i*t\i, 


THE 

ARTHUR  YOUNG 

ACCOUNTING 

COLLECTION 


Graduate  School  of 
Business  Administxation 

Library  of  the 

University  of  California 

Los  Angeles 


SOUTHERN  BRANCH 

UNIVERSITY  OF  CALIFORNIA 
LIBRARY 

LOS  ANGELES.  CAUP. 


ACCOUNTING    PRINCIPLES 


THE  MAOflLLAN  COMPANY 

NEW  YORK   •    BOSTON    •    CHICAGO 
DALLAS       ATLANTA   •    SAN  FRANCISCO 

MACMILLAN  &  CO..  Limited 

LONDON    ■    BOMBAY    •    CALCUTTA 
MELBOURNE 

THE  MACMILLAN  CO.  OF  CANADA,  Lm 

TORONTO 


ACCOUNTING 
PRINCIPLES 

THEIR   USE  IN  BUSINESS  MANAGEMENT 


BY 

SPURGEON  BELL,  M.B.A. 

PROFESSOR   OF    BUSINESS    ADMINISTRATION 
IN   THE   UNIVERSITY   OF   TEXAS 


IRew  Ifforft 

THE   MACMILLAN   COMPANY 

1921 


All  rights  reserved 

4^044 


PRINTED  tS  THE   UNITED  STATES  OF  AMERICA 


COPXWGHT,  1919, 

By  sturgeon  BELL 


Copyright,  1921, 
By  the  MACMILLAN  COMPAVS' 


Setupandelectrotypcd.    Published   December.  i9ai. 


Bus.  Admin, 
library 


TO  MY  FORMER  TEACHER  AND  COLLEAGUE 

PROFESSOR    H.    J.    DAVENPORT 

THIS  BOOK  IS  AFFECTIONATELY  DEDICATED 


Digitized  by  tine  Internet  Arciiive 

in  2007  witii  funding  from 

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•  V 


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PREFACE 


It  has  been  the  aim  m  the  preparation  of  this  book  to  pre- 
sent the  principles  of  accounting  in  their  relation  to  business 
management.     An  effort  has  been  made  to  aid  the  reader  in 
a  ready  grasp  of  the  principles  by  the  free  use  of  illustrative 
solutions  of  problems  and  exercises.     These  illustrative  solu- 
tions also  serve  a  useful  purpose  in  the  teaching  of  good  form 
in  accounting  work. 
1     The  business   man,  who  lacks   the  time   to  work  through 
^  tedious  routine,  will  find  that  the  illustrative  forms  and  solu- 
C  tions  which  are  presented  in  connection  with  the  discussion 
of  the  principles  will  facilitate  an  understanding  of  the  sub- 
Q  jects  discussed.     He  will  also  find  that  the  text  has  many 
^  accounting  forms  and  statement  forms  which  will  make  it  a 
J  useful  reference  volume. 

The  text  is  supplied  both  with  special  problems  and  exer- 

.  cises  illustrating  the  principles  of  the  separate  chapters  and 

cl  with  a  set  of  business  transactions  designed  to  form  the  basis 

f'  for  a  continuous  set  of  books  illustrative  of  accounting  prin- 
''  ciples  for  a  small  individual  business,  a  partnership,  and  a  cor- 
poration. In  the  continuous  set  the  student  will  have  good 
discipline  in  opening  the  books,  in  transferring  a  business,  and 
in  arranging  for  a  continuous  routine  such  as  may  be  involved 
in  carrying  forward  a  regular  set  of  books.  A  more  hasty 
reading  of  the  book  by  one  already  trained  in  routine  need 
not  involve  the  more  tedious  work  of  the  continuous  set. 

The  exercise  and  problem  material  of  the  text  have  been 
developed  during  eight  years  of  teaching  of  the  Principles  of 
Accounting.  During  five  of  these  eight  years  the  late  Major 
J.  E.  Treleven  was  associated  with  the  author  in  accounting 
instruction,   and   contributed   much   of   the   special   problem 


Vlll 


PREFACE 


material  found  in  the  text.  He  also  criticised  the  exercise 
material  and  assisted  in  its  preparation.  The  author  wishes 
also  to  acknowledge  his  obligation  to  his  colleague,  Mr.  F.  W. 
Graff,  for  criticism  and  improvement  in  the  English  of  the 
manuscript. 

The  author  wishes  to  call  special  attention  to  the  sets  of 
ruled  note  paper  furnished  by  the  publisher  to  be  used  with 
this  text. 


TABLE   OF    CONTENTS 

CHAFTER  PAGE 

I    The  Balance  Sheet          i 

II    IiiCOMES  AND  Expenses     .        .' 12 

III  The«  Accounts  and  Their  Relation  to  the  Statement  21 

IV  The  Journal  and  Ledger 43 

V    The  Form  and  Use  of  Commercial  Papers          .        .  56 

VI    .The  Divided  Journal  and  the  Trading  Account        .  71 

VII    Janu.\ry  Transactions  of  the  Valley  Furniture  Store  92 

VIII    Petty  Cash 106 

IX    Apportionment  of  Expenses  to  Appropriate  Period  — 

Depreciation  and  Repairs 112 

X     Closing  and  Opening  Entries  Involved  in  the  Transfer 

of  a  Business 130 

XI    Apportionment  of  Income  and  Expense        .        .        .  135 
XII    Interpretation  and  Managerial  Use  of  the  Revenue 

Statement 146 

XIII  The  Form  and  Managerial  Use  of  the  Balance  Sheet  162 

XIV  Internal  Analysis   op   Balance   Sheet  and   Re\enut; 

Statement 182 

XV    Controlling  Accounts  and  Colutinar  Books       .        .  187 

XVI    The  Bill  Book    *" 214 

XVn    Transactions  for  February 222 

XVni    Closing  the  Books  for  Periodical  Reports        .        .  239 

XIX    Consignments 245 

XX    Transactions  for  March 285 

XXI    The  Incoming  and  Withdrawal  of  Partnt:r5      .        .  294 

XXII    Distribution  of  the  Partnership  Profits    .        .        .  305 

XXIII  Liquidation  of  a  Solvent  Partnership         .        .        .313 

XXIV  Corporate  Organization  and  Accounting     .        .        .328 
XXV    Capital  Stock  Accounts  and  the  Issue  of  Corporate 

Shares 342 


X  TABLE  OF  CONTENTS 

CHAFTEX  PAGE 

XXVI    Changixg  to  the  Corporate  Form  of  Organization      .  35  2 

XXVII    Bond  Account 364 

XXVni     Changes  in  the  Value  of  the  Proprietary  Interest 

OF  THE  Corporation      .        .        .        .      ■  .        .        .  375 

XXIX    Corporation  Records 399 

XXX    Cost  Accounts  ant)  Types  of  Cost  Accounting  .        .410 
XXXI    The  Man^ufacturing  Profh  and  Loss  Statement       .  433 
XXXn    The  Voucher  Record  an"d  the  Estimating  Cost  System  447 
XXXlll    Opening  the  Corporation  Books  for  April  Transac- 
tions         458 

ApPE>a>rx:  The  Working  Sheet 475 

LsTJEX .           .  470 


LIST   OF    ILLUSTRATIONS 

PAGE 

1.  An  Account  with  a  Customer 22 

2.  Cash  Account 25 

3.  An  Account  with  a  Creditor 27 

4.  Merchandise  Account 31 

5.  Set  of  Accounts 37 

6.  Journal  Entries ,  .        -49 

7.  Purchase  Invoice *     •  57 

8.  Promissory  Note 59 

9.  Bill  of  Exchange 62 

10.  Check 64 

11.  Bank  Draft 64 

12.  The  Divided  Journal 78 

13.  Petty  Cash  Book 108 

13A.  Petty  Cash  Book 109 

14.  Condensed  Statement  of  Departmental  Profits  .        .        -151 

15.  Merchandise  Stock  Ledger 153 

16.  Pro  Forma  Revenue  Statement 157 

17.  Comparative  Revenue  Statements       .        .        .        .        .        -159 

18.  Form  of  General  Balance  Sheet  Statement  as  Prescribed  by  the 

Interstate  Commerce  Commission  for  Steam  Roads         .        .  169 

19.  Estimated  Receipts  and  Disbursements        .....  174 

20.  Valley  Furn.  Co.  —  Comparative  Balance  Sheet,  December  31  175 

21.  Account  Form  of  Balance  Sheet 176 

22.  Columnar  Journal  and  Controlling  Accounts       ....  200 

23.  Notes  Receivable  Journal             216 

23A.  Notes  Payable  Journal 218 

24.  Sales  Register,  Including  Provision  for  Consignment  Sales        .  246 

25.  Account  Sales 250 

26.  The  Book  of  the  Consignor 262 

27.  Valley  Furn.  Co.  —  Comparative  Balance  Sheet        .        .        .  339 


xii  LIST  OF  ILLUSTR.\TI0NS 

PAGE 

28.  Subscription  Blank 399 

29.  Subscription  Installment  No.  i 400 

30.  Subscription  Ledger 401 

31.  Stock  Transfer 403 

32.  Stock  Ledger 405 

33.  Bond  Register 406 

34.  Coupon  Bond  Register 408 

35.  Fonn  for  Revenue  Statement  Manufacturing  and  Merchandising 

Business  Combined 434 

36.  Valley  Furn.  Co.  —  Manufacturing  Statement  (Comparative)     .  440 

37.  Voucher  Register 450 

38.  Voucher  (Front) 452 

39.  Voucher  Check             454 

40.  Profit  and  Loss  (Sectionalized)             474 


ACCOUNTING   PRINCIPLES 


ACCOUNTING   PRINCIPLES 


CHAPTER   I 
THE  BALANCE   SHEET 

1.  Property.  —  The  word  property  signifies  things  that  are 
owned  by  an  individual,  a  firm,  or  a  corporation.  These  things 
may  consist  of  houses,  lands,  stocks,  bonds,  mortgages,  evi- 
dences of  debt  (such  as  open  accounts  and  notes),  franchises, 
goodwill,  and  other  valuable  rights  —  in  short,  of  anything, 
either  tangible  or  intangible,  with  which  the  owner  would  not 
ordinarily  part  without  a  consideration.  Property  is  also  fre- 
quently spoken  of  as  assets.  The  assets  of  an  individual,  a  firm, 
or  a  corporation,  therefore,  are  all  the  property  that  each  may 
own. 

2.  The  Business  Unit.  —  Much  confusion  will  be  saved  if 
the  student  will  from  the  beginning  think  of  the  ownership  of 
property  and  of  the  conduct  of  a  business  in  terms  of  the  busi- 
ness itself,  rather  than  in  terms  of  the  individuals  who  may  de- 
rive certain  benefits  therefrom.  The  business,  whether  con- 
trolled by  an  individual,  a  firm,  or  a  corporation,  owns  all  the 
assets  of  the  concern,  and  holds  them  subject  to  the  claims  of 
the  proprietors  and  creditors.  In  fact,  a  business  is  frequently 
thought  of  as  owing  some  one  for  all  the  assets  that  it  may  hold. 

3.  The  Individual  Business  Unit.  —  The  assets  of  a  business 
controlled  by  an  individual  are  not  necessarily  all  owned  by 
the  particular  individual,  though  they  are,  of  course,  all  owned 
by  the  business  itself.  The  individual  may  contribute  all  the 
assets  of  the  business,  in  which  case  the  business  owes  no  one 
except  the  owner.  His  interest  is  ordinarily  called  the  propri- 
etary interest  or  proprietorship.  Frequently,  however,  a  busi- 
ness buys  merchandise  on  credit  from  outside  parties  without 
giving  to  them  any  power  of  control  over  the  business  except 


2  ACCOUNTING   PRINCIPLES 

such  as  might  accrue  through  nonpayment  of  the  obligations 
due.  Where  such  purchases  are  made,  the  business  is  indebted 
to  the  owner  for  his  contribution  of  assets  and  to  the  outside 
parties  for  the  merchandise  bought.  An  individual  may,  there- 
fore, be  the  owner  of  a  controlling  interest  though  not  of  all 
the  assets  of  a  business.  A  business  is  sometimes  spoken  of  as 
an  enterprise,  and  the  owner  of  the  controlling  interest  as  the 
enterpriser. 

The  debts  or  liabilities  of  a  business  controlled  by  an  indi- 
vidual are  ordinarily  paid,  when  due,  by  the  business  itself. 
Should  the  business  be  unable  to  meet  its  obligations  at  matur- 
ity, the  owner  must  pay  them  out  of  other  property  or  assets 
he  may  own,  even  though  the  business  is  indebted  to  him  for 
the  assets  he  has  contributed  to  it.  In  other  words,  the  debts 
of  the  business  become  the  debts  of  the  owner  or  enterpriser 
whenever  the  business  is  unable  to  pay  them.  Whenever  all 
the  assets  are  sold  the  cash  proceeds  must  be  applied  first  to 
pay  all  liability  interests.  The  balance  is  then  distributed  to 
the  proprietors  on  the  basis  of  their  proprietary  interests. 

4.  The  Firm  or  Partnership.  —  Whenever  two  or  more  indi- 
viduals combine  to  secure  the  controlling  interest  in  an  enter- 
prise under  the  terms  of  what  may  be  called  a  general  partner- 
ship, they  each  assume  the  same  responsibility  for  the  debts  of 
the  business  that  the  single  individual  assumes  for  the  debts  of 
the  individual  business.  The  firm  itself  is  initially  responsible 
for  its  debts;  but,  if  the  business  cannot  pay  them,  the  mem- 
bers of  the  firm  or  partnership  are  jointly  and  severally  re- 
sponsible and  must  meet  the  claims  from  other  property  or 
assets  owned  by  them. 

5.  The  Limited  Partnership.  —  Many  of  the  states  have 
passed  laws  providing  for  the  organization  of  limited  partner- 
ships, where  the  members  are  not  responsible  for  all  of  the 
debts  created  by  the  firm.  The  rules  and  regulations  under 
which  such  firms  are  organized  vary,  of  course,  in  the  several 
states. 

6.  The  Corporation.  —  The  corporation  is  the  most  con- 
venient form  of  organization  for  securing  a  large  amount  of 


THE   BALANCE   SHEET  3 

assets  under  the  control  of  a  single  business  unit.  A  corpora- 
tion ordinarily  has  shares  of  stock  of  a  given  par  value,  the 
ownership  of  more  than  half  the  shares  giving  control  of  the 
corporation.  Although  the  stockholders  have  the  power  to  con- 
trol the  business,  they  ordinarily  vest  this  power  in  a  board  of 
directors.  The  board  of  directors  in  turn  selects  officers  to  con- 
duct the  business.  The  corporation,  like  other  forms  of  business 
units,  borrows  money  and  buys  assets  on  time.  It  is  therefore 
indebted,  not  only  to  the  stockholders  for  the  funds  they  have 
invested,  but  frequently  to  outside  parties  for  goods  bought  on 
credit  and  for  money  borrowed.  The  stockholders,  however,  do 
not  become  personally  responsible  for  the  debts  of  the  corpora- 
tion, except  to  the  extent  of  their  interest  in  its  assets.  The 
business  itself  is  solely  responsible  for  debts,  and  only  its  assets 
can  be  drawn  on  to  pay  the  debts  of  the  business  in  case  they 
are  not  paid  in  the  regular  course  of  operation. 

7.  Liabilities  and  Proprietorship.  —  The  foregoing  is  a  brief 
statement  of  the  nature  of  business  units,  made  for  the  purpose 
of  throwing  light  on  the  meaning  of  assets  and  liabilities.  The 
assets  of  a  business  unit,  as  indicated  in  the  beginning,  are  the 
things  owned. 

The  claim.s  against  assets  are,  then,  divided  into  two  classes 
or  equities:  (a)  liabilities,  and  (b)  proprietorship.  The  owners 
of  these  claims  are  the  parties  interested  in  the  business  unit. 
The  owners  of  the  proprietary  interest  control  the  property  and 
supervise  its  operation  so  long  as  the  business  is  able  to  comply 
with  its  contracts  with  the  owners  of  liability  claims.  It  is, 
however,  frequently  provided  in  the  contract  between  the 
business  and  the  holders  of  liability  claims  that  the  latter  take 
control  of  the  business  if  it  fails  to  comply  with  its  contract 
obligations  to  the  owners  of  these  liability  interests. 

It  is  common  in  accounting  literature  to  see  a  general  equa- 
tion or  general  foundation  principle  laid  down  in  the  form  of 
the  statement  that  "the  assets  less  liabilities  equal  proprietor- 
ship." Of  course  it  is  just  as  true  that  assets  less  proprietor- 
ship equal  the  liabilities.  The  reason  that  both  of  these  gener- 
alities are  true  lies  in  the  more  fundamental  fact  that  the  total 


4  ACCOUNTING  PRINCIPLES 

of  ownership  in  assets  is  equal  to  the  total  of  assets,  since  both 
the  ownership  and  the  assets  are  expressed  in  terms  of  dollars. 
No  assets  are  contributed  to  business  under  a  system  of  private 
enterprise  unless  the  contributor  receives  in  exchange  a  claim 
against  the  assets  equal  to  the  valuation  or  price  placed  on  the 
asset  received  by  the  business  unit  which  receives  it.  Of  course 
a  business  unit  may  receive  certain  assets  and  exchange  there- 
for some  other  asset  of  equal  value,  but  there  arises  no  increase 
in  assets  by  such  an  exchange.  All  increases  in  the  total  assets 
of  a  business  are  accompanied  by  a  like  increase  in  the  out- 
standing claims  against  the  assets,  the  increase  taking  the  form 
of  an  increase  in  either  the  liability  claims  or  in  the  proprietor- 
ship claims. 

8.  Proprietorship.  —  In  the  case  of  the  individual  business 
the  proprietorship  claim  is  ordinarily  spoken  of  as  the  capital 
of  the  proprietor.  In  the  case  of  the  partnership  the  propri- 
etary interest  consists  of  the  ownership  claims  of  the  partners 
which  are  called  their  capitals.  When  an  entirely  new  corpora- 
tion is  organized  it  begins  ordinarily  with  a  proprietary  interest 
represented  by  the  capital  stock  or  capital  shares  of  the  own- 
ers. The  par  value  of  these  shares  is  generally  held  to  repre- 
sent the  investments  of  the  proprietors  in  the  business.  If 
these  shareholders  turn  over  property  to  the  corporation  in 
payment  for  their  interests,  this  property  is  frequently,  in  fact, 
worth  less  than  may  be  indicated  by  the  par  value  of  the  shares 
received  by  the  proprietors  in  question.  The  laws  of  the 
various  states  generally  require  that  only  paid-up  shares  may 
be  issued,  but  at  the  same  time  these  states  do  not  so  interpret 
and  administer  these  laws  that  one  can  feel  assured  that  the 
par  value  of  the  shares  issued  always  signifies  the  value  of  the 
investments  originally  made  by  the  proprietors.  Increases  in 
the  proprietary  interest  arising  from  ordinary  business  opera- 
tions are  added  directly  to  capital  in  the  case  of  the  individual 
business  and  in  the  case  of  the  partnership.  The  corp)oration 
does  not  increase  the  issue  of  capital  shares  except  by  special 
authorization  of  the  directors.  The  ordinary  increases  in  pro- 
prietorship of  the  corporation  are  recorded  under  the  caption  of 


THE  BALANCE  SHEET  5 

surplus,  so  that  the  entire  interest  of  the  proprietor  is  repre- 
sented by  the  capital  stock  plus  the  surplus. 

9.  Balance  Sheet.  — •  A  balance  sheet  is  a  statement  of  the 
assets  and  liabilities  of  a  business.  It  may  be  illustrated  for 
the  several  types  of  business  units  as  follows: 

10.  The  Balance  Sheet  of  the  Individual  Business.  — 

JOHN  I  SMITH 
Balance  Sheet,  December  31,  1918 

Liabilities 
Notes  Payable — Bank  $2,000 .  00 
Accounts  Payable 

Valley  Furn.  Co.        2,500.00 
Rocky  Mountain 

Univ.  500 .  00 

Desk  and  Chair  Co.    1,500.00 

Mortgage  Payable        10,000.00 

John  Smith,  Capital   21,975.00 

(//  -  L  -^J3.^il.)  

$38,475.00 


Assets 

Cash 

$5,400 .  00 

Notes  Receivable 

4,500.00 

Accounts  Receivable 

John  Jones 

500.00 

Ralph  Reynor 

300.00 

C.  R.  Kenedy 

275.00 

Merchandise  Inventory  10,000.00 

Buildings 

7,500.00 

Land 

10,000.00 

$38,475.00 

II.  The  Balance  Sheet  of  the  Partnership  and  the  Corpora- 
tion. —  If,  in  the  foregoing  statement,  we  should  substitute  for 
the  item  John  Smith,  Capital,  $21,975.00,  the  following  items  — 

John  Smith,  Capital    ....    $10,975.00 
John  Randolph,  Capital    .      .      .      11,000.00 

we  should  have  the  balance  sheet  of  the  partnership  firm  of 
Smith  and  Randolph. 

If,  for  the  same  item,  we  should  substitute  the  following 

Capital  Stock $20,000.00 

Surplus 1,975.00 

we  should  have  the  balance  sheet  of  the  corporation. 

It  is  evident,  therefore,  that  there  is  no  difference  in  the  bal- 
ance sheets  of  the  various  types  of  business  organizations  ex- 
cept in  the  form  of  the  statement  of  the  liability  to  the  owners, 
or,  if  there  is  objection  to  calling  the  capital  account  a  liability 
account,  in  the  form  of  the  statement  of  the  net  worth  or  pro- 
prietorship interest. 


6  ACCOUNTING  PRINCIPLES 

12.  The  Financial  Statement.  —  Many  accounting  texts,  in 
order  to  bring  out  clearly  that  the  net  worth  or  proprietorship 
interest  of  a  business  unit  is  always  found  by  subtracting  the 
outside  liabilities  from  the  total  assets,  adopt  the  financial 
statement  form  of  setting  forth  the  assets  and  liabilities.  This 
form  may  be  illustrated  as  follows: 

JOHN  SMITH 

Financial  Statement,  December  31,  1918 

Assets,  or  Resources 


Cash 

$5,400.00 

Notes  Receivable 

4,500.00 

Accounts  Receivable 

John  Jones 

$500.00 

Ralph  Reynor 

300.00 

C.  R.  Kenedy 

275.00 

1,075.00 

Merchandise 

10,000.00 

Buildings 

7,500.00 

T«ind 

10,000.00 

Total  Assets 

$38,475.00 

Liabilities 

Notes  Payable — Bank 

2,000.00 

Accounts  Payable 

Valley  Furniture  Co. 

$2,500.00 

Rocky  Mountain  Univ. 

500.00 

Desk  and  Chair  Co. 

1,500.00 

84,500.00 

Mortgage  Payable 

10,000.00 

Total  Liabilities 

16,500.00 

Net  Worth  (John  Smith,  Capital) 

$21,975.00 

From  this  illustration,  it  is  e\adent  that,  so  far  as  the  finan- 
cial statement  is  employed,  it  serves  mainly  to  emphasize  that 
the  net  worth  or  proprietorship  interest  is  the  balance  resulting 
from  the  subtraction  of  the  outside  liabilities  from  the  total 
assets.  The  use  of  the  balance  sheet,  however,  for  this  purpose 
may  be  entirely  defended  on  the  ground  that  the  balance  of 
an  account  is  usually  set  down  as  the  last  item,  without  any 
actual  subtraction.    Indeed,  the  balance  sheet,  and  not  the 


THE  BALANCE  SHEET  7 

financial  statement,  is  the  form  commonly  used  in  published 
financial  exhibits. 

13.  The  Order  of  the  Statement  of  Assets  and  Liabilities  in 
the  Balance  Sheet.  —  For  a  merchandise  concern,  the  usual 
order  of  assets  and  liabilities  is  that  found  in  the  balance  sheet 
given  above.  This  order  is  essentially  for  the  benefit  of  the 
creditors,  who  are  most  interested,  on  the  one  hand,  in  the 
cash  items  and  the  items  currently  turned  into  cash,  and,  on 
the  other,  in  the  items  that  must  be  met  from  month  to  month 
out  of  the  proceeds  of  current  operations.  The  capital  item  is 
usually  placed  last,  being  regarded  as  the  balance  of  the  in- 
vestment of  the  owners  in  the  enterprise. 

This  question  of  the  order  of  items  will  recur  as  other  state- 
ments are  made  from  time  to  time. 

14.  Grouping  of  Assets  and  Liabilities.  —  It  is  not  sufficient 
for  all  purposes  to  know  simply  the  totals  of  assets,  liabilities, 
and  proprietorship.  If  John  Smith  had  no  liabilities  and  asked 
a  bank  loan  of  $20,000.00,  the  bank  would  wish  to  know  not 
merely  the  total  assets  but  the  character  of  the  assets.  How 
much  of  these  assets  could  be  readily  turned  into  cash?  How 
much  of  the  assets  will  be  sold  in  the  next  sixty  to  ninety  days 
in  the  ordinary  course  of  business?  If  the  bank  loan  is  to 
mature  in  ninety  days,  there  must  be  in  sight  some  source  from 
which  the  funds  are  to  be  secured  to  liquidate  the  bank  loan. 
If  the  borrowed  funds  themselves  are  to  be  used  to  purchase 
goods  which  will  be  sold  within  ninety  days,  the  sale  of  the 
goods  will  furnish  the  funds  to  pay  the  loan.  If  the  business 
had  in  addition  other  goods  which  will  be  sold,  the  security  of 
the  loan  is  further  improved.  The  bank  would  consequently 
ask  John  Smith  to  present  a  balance  sheet  showing  the  assets 
which  are  to  be  turned  into  cash  in  the  ordinary  course  of  busi- 
ness.   These  assets  are  called  the  current  assets. 

The  assets  which  are  to  be  used  regularly  in  connection  with 
the  business  and  were  not  purchased  for  sale  are  the  fixed 
assets.  They  are  not  looked  to  as  the  source  of  the  funds 
which  may  be  used  to  pay  current  loans  to  banks  and  other 
creditors.    They  would  be  of  particular  significance  in  connec- 


^  ACCOUNTING  PRINCIPLES 

tion  with  long-time  loans  and  are  of  some  significance  even  in 
connection  with  short-time  loans. 

There  is  another  tvpe  of  asset  which  is  of  the  nature  of  a 
supply  to  be  used  up  in  current  operation  but  not  sold.  These 
supplies  are  sometimes  called  deferred  expense  because  they  will 
become  an  exp)ense  as  they  are  used  up  in  regular  operations. 
Other  expenses  paid  in  advance  are  likewise  put  in  the  same 
class  of  items.  These  items  are  not  expected  to  be  sold  for 
cash,  but  their  cost  will  generally  be  covered  by  the  sale  price 
of  merchandise. 

15.  Grouping  of  the  Liabilities.  —  If  loans  are  to  be  made 
to  a  business  which  already  has  liabilities  outstanding,  these 
become  at  once  an  important  consideration.  It  is  dangerous 
to  lend  to  a  business  which  may  be  imable  to  meet  any  of  its 
liabilities.  Moreover,  the  ability  of  a  business  to  pay  a  par- 
ticular liability  at  maturity  depends  to  some  extent  on  the 
other  liabilities  which  may  be  outstanding,  and  on  the  date  of 
the  maturity  of  these  liabilities.  It  is,  therefore,  customar>'  to 
classify  the  habilities  on  the  basis  of  the  date  of  pajnnent.  If 
liabihties  are  to  be  paid  out  of  the  proceeds  of  sale  and  during 
the  current  fiscal  period  they  are  generally  classified  as  current 
li<jbUUies.  Accounts  payable  and  notes  payable  are  current 
liabihties.  The  mortgage  liabilit'ies,  the  bond  liabihties,  and 
the  notes  having  a  long  period  to  run  are  classified  as  fixed  lia- 
bilities. It  is  also  true  of  these  liabilities  that  their  ultimate 
pajTiient  is  generally  provided  for  either  by  provisions  for  grad- 
ual accumulation  of  an  amount  sufficient  to  pay  the  debt  at 
maturity  or  by  the  issue  of  new  notes,  bonds,  or  liabilities, 
which  will  furnish  the  funds  for  the  retirement  of  the  old  lia- 
bihties. These  fixed  liabilities  are  also  frequently  cailed  funded 
liabilities.  There  are  other  classes  of  liabilities  and  also  sub- 
divisions of  the  proprietary  interest  which  v^-ill  be  discussed  in 
later  chapters. 

16.  Balance  Sheet  with  Items  Grouped.  —  The  following 
balance  sheet  of  John  Smith  shows  the  items  grouped  so  that 
the  statement  would  serve  the  purpose  of  showing  the  credit 
position  of  the  business: 


THE  BALANCE   SHEET 


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ACCOUNTING  PRINCIPLES 


17.  Financial  Statement  —  The  balance  sheet  above  is  stated 
in  the  form  of  an  account  with  assets  appearing  as  debits,  the 
liabilities  as  credits  and  the  proprietorship  as  a  balance  of  the 
account.  This  form  of  statement  is  easily  read  and  interpreted 
by  one  who  knows  accounting,  but  the  same  facts  can  be  indi- 
cated more  plainly  to  a  general  reader  by  the  financial  state- 
ment form  as  follows: 

JOHN  SMITH 

Financial  Statement,  December  31,  1920 

Assets 


Current  Assets 

Cash 

$5,400.00 

Notes  Receivable 

4,500.00 

Accounts  Receivable 

John  Jones 

$500.00 

Ralph  Reynor 

300.00 

C.  R.  Kenedy 

275.00 

1,075.00 
10,000 .  00 

Merchandise 

Deferred  Expense 

Office  Supplies 

500.00 

Fuel  Supphes 

900.00 

Insur.  paid  in  adv. 

100.00 

1,500.00 

Fixed  Assets 

Buildings 

6,000.00 

T^and 

10,000.00 

16,000.00 

Total  Assets 

Liabilities 

$38,475.00 

Currait  Liabilities 

Notes  Payable — Bank 

2,000.00 

Accounts  Payable 

Valley  Fum.  Co. 

2,500.00 

Rocky  Mt.  Univ. 

500.00 

Desk  and  Chair  Co. 

1,500.00 

4,500.00 

Fixed  Liabilities 

Mortgage  Payable 

10,000.00 

Total  Liabilities 

16,500.00 

Net  Worth  (John  Smith,  Capital) 

$21,975.00 

THE  BALANCE  SHEET  li 


PROBLEMS  AND  QUESTIONS 

1.  On  the  books  of  D.  F.  Payne,  the  owner  of  a  general  merchandise 
business,  there  appear  the  following  items:  notes  payable,  $1500.00; 
accounts  payable,  $200.00;  buildings,  $4000.00;  land,  $1600.00;  horse 
and  wagon,  $250.00;  cash,  $3286.00;  accounts  receivable,  $iioo.oo. 

(a)  What  is  the  capital  account  of  D.  F.  Payne?  (b)  Arrange  the  items 
into  a  balance  sheet  as  of  December  31,  1919.  (c)  Arrange  the  items  into 
a  financial  statement  as  of  December  31,  1919. 

2.  In  the  balance  sheet  of  John  Smith  as  given  in  the  text,  cash  was  set 
down  first;  notes  receivable,  second;  accounts  receivable,  third;  merchan- 
dise, fourth,  etc.     Give  the  reason  for  this  order. 

3.  Give  the  reason  for  the  arrangement  of  the  liabilities  in  the  order 
found  in  the  same  balance  sheet. 

4.  In  the  balance  sheet  of  John  Smith,  which  liabilities  represent  the 
probable  source  (a)  of  the  merchandise  inventory;  (b)  of  the  cash;  (c)  of  the 
land  and  buildings? 

5.  In  case  of  the  dissolution  of  a  business  controlled  by  an  individual 
or  a  partnership,  as  illustrated  in  the  balance  sheets  of  John  Smith  and  of 
Smith  and  Randolph,  imder  what  condition  would  the  owner  or  owners  (a) 
get  their  investment  of  $21,975.00  out  of  the  business;  (b)  lose  more 
than  $21,975.00? 

6.  In  case  of  the  liquidation  or  dissolution  of  the  corporation  illustrated 
in  the  text,  with  a  capital  stock  of  $20,000.00  and  a  surplus  of  $1975.00, 
what  is  the  maximum  amount  that  the  shareholders  stand  to  lose? 

7.  Make  a  balance  sheet  with  items  grouped  from  the  data  of  question 
No.  I  above. 


CHAPTER  II 
INCOMES  AND  EXPENSES 

I.  Income  Items.  —  No  income  items  are  found  in  the  bal- 
ance sheet  given  in  Chapter  I.  They  represent  increases  in 
capital  or  proprietorship  claims  which  have  taken  place  in  a 
period  prior  to  the  date  of  the  balance  sheet.  Instead  of  sim- 
ply adding  all  these  increases  in  capital  directly  to  the  capital 
item,  they  are  analyzed  according  to  the  som-ces  from  which 
the  incomes  are  received.  They  arise  mainly  from  the  sale  of 
merchandise.  Merchandise  consists  of  those  goods  which  are 
bought  to  sell.  At  any  particular  time  the  total  of  these  goods 
is  called  the  merchandise  inventory.  The  business  is  carried 
on  mainly  for  the  purpose  of  selling  the  merchandise  at  a  price 
in  excess  of  what  it  cost  with  a  view  to  increasing  the  capital  or 
the  proprietorship  interest. 

The  student  frequently  confuses  the  property  or  asset  received 
with  the  name  of  the  source  from  which  the  asset  is  received. 
Cash  may  be  received  from  the  sale  of  merchandise,  but  the 
name  of  the  revenue  item  involved  is  merchandise  sales.  No 
asset  or  property  item  should  be  designated  as  an  income  item. 
•  If  a  transaction  takes  place  which  increases  one  asset  item 
and  decreases  another  by  the  same  amount,  no  income  item  is 
affected.  For  example,  accounts  receivable  are  paid  from 
time  to  time  by  customers  without  affecting  the  total  assets 
which  a  business  owns.  Cash  is  increased  by  exactly  the  same 
amount  that  accounts  receivable  are  decreased. 

Income  may  arise  also  from  other  sources  such  as  rent  of 
office  space  and  perhaps  from  some  business  side  line  such  as  a 
repair  shop.  The  income  from  such  sources,  however,  is  com- 
monly small  as  compared  with  the  income  from  sales.  All  of 
these  incomes  are  alike  in  that  they  represent  increases  in  what 
the  business  owns.  They  are  increases  in  capital  or  proprietor- 
ship. They  are  not  the  actual  assets  in  which  these  increases 
in  ownership  are  embodied.    These  assets  may  be  cash,  ac- 

Z2 


INCOMES  AND  EXPENSES  13 

counts  receivable,  etc.,  but  the  revenue  item  is  the  name  of 
the  source  from  which  the  increase  in  assets  was  received. 
These  income  items  are,  of  course,  temporary  items,  since  they 
are  from  time  to  time  added  in  total  to  the  capital  and  simply 
serve  as  an  explanation  of  the  sources  from  which  the  increase 
in  capital  was  derived. 

2.  Expenses.  —  These  incomes,  however,  are  subject  to  cer- 
tain deductions  before  the  net  is  added  to  capital.  The  ex- 
penses are  the  cost  which  a  business  incurs  in  connection  with 
getting  its  income.  The  purchase  price  of  the  goods  sold  rep- 
resents a  cost  which  must  be  deducted  from  sales  before  any 
net  income  could  be  added  to  capital.  There  are  other  deduc- 
tions such  as  salaries  of  the  sales  force,  the  salaries  of  the  ad- 
ministrative force,  the  expense  of  advertising,  the  expense  of 
stationery  and  printing,  etc.  WTien  all  of  the  expenses  thus 
incurred  have  been  deducted  from  the  incomes  received,  the 
balance  is  added  to  capital  as  an  increase  in  capital  or  in  the 
proprietorship  interest. 

It  is  to  be  noted  that  the  expenses  are  simply  the  classified 
names  of  the  causes  of  expense.  They  are  not  the  names  of  the 
property  items  which  the  business  may  sacrifice  in  getting  the 
net  profit  which  is  added  to  capital.  The  business  may  part 
with  cash  when  it  pays  for  goods  purchased,  but  merchandise 
purchases  represents  the  expense  item  which  must  be  deducted 
from  the  merchandise  sales  by  reason  of  this  sacrifice  of  cash. 

Expenses  are  deductions  from  capital  or  proprietorship.  In- 
stead, however,  of  adding  incomes  to  capital  and  deducting  ex- 
penses from  capital,  the  expenses  are  commonly  deducted  from 
the  income  so  as  to  get  a  net  profit,  which  is  added  to  capital. 
If  the  expenses  were  greater  than  the  income,  the  business 
would  be  operating  at  a  loss,  and  the  loss  would  be  deducted 
from  capital  or  the  proprietorship  interest. 

Instead  of  deducting  all  expenses  in  a  lump  sum  from  the 
total  of  income  in  the  calculation  of  net  profit,  a  number  of 
sub-totals  are  derived  showing  what  is  left  of  the  income  after 
certain  classes  of  expenses  have  been  deducted.  The  state- 
ment formulated  in  connection  with  the  calculation  of  these 


14  ACCX)UNTING  PRINCIPLES 

sub-totals  is  called  a  Revenue  Statement,  or  a  Profit  and  Loss 
Statement. 

3.  Merchandising  Differentials.  —  The  purchase  price  of  the 
goods  plus  the  freight  and  other  charges  incurred  in  transport- 
ing them  to  the  place  of  sale  is  called  the  cost  of  the  goods.  The 
difference  between  the  total  proceeds  of  the  sale  of  the  goods 
and  the  cost  of  the  goods  sold  is  called  the  gross  profits.  If 
from  the  gross  profits  are  subtracted  the  operating  expenses,  there 
remains  a  balance  ordinarily  called  the  profiis  from  operation. 

The  operating  expenses  of  a  business  include  every  loss  and 
expense  in  connection  with  the  sale  of  its  goods  and  the  con- 
duct of  the  business  organization.  The  money  paid  for  rent, 
the  salaries  of  those  engaged  in  buying  and  selling,  the  salaries 
of  those  who  keep  the  records,  and  the  salaries  of  those  who 
manage  the  business  are  all  parts  of  the  operating  expenses. 
In  other  words,  these  payments  are  not  made  for  assets  which 
remain  with  the  business,  but  are  absorbed  in  disposing  of  goods 
which  have  been  bought  for  sale.  In  buying  and  selling  goods, 
tlierefore,  the  manager  always  strives  to  make  the  profits  from 
operation  as  large  as  he  can.  He  keeps  a  close  record  of  operat- 
ing expenses,  in  order  to  make  such  e.xp>enses  as  small  as  possible. 
Operating  exjjenses  are  sometimes  classified  into  selling  expenses, 
administrative  expenses,  general  expenses,  etc.  The  larger  the 
business,  the  more  numerous  the  classes  of  operating  expense. 

Interest  on  funds  borrowed  to  carry  on  a  business  is  not  or- 
dinarily classed  with  operating  expenses,  but  is  carried  in  a 
special  section  of  the  revenue  statement.  Interest  represents 
an  earning  or  income  to  at  least  a  part  of  those  who  hold  defi- 
nite liability  claims  against  the  assets,  whereas  operating  ex- 
penses proper  do  not  represent  any  p)art  of  the  earnings  of  a 
business  that  can  be  distributed  to  holders  of  claims  against 
the  assets.  In  other  words,  operating  exp>enses  are  not  pay- 
ments for  the  use  of  the  funds  which  the  business  owns. 

Moneys  received  from  subsidiary  enterprises  are  also  treated  in 
a  separate  section  of  the  revenue  statement,  designated  as  Other 
Income.  Profits  from  operation  plus  other  income  constitute  the 
total  income,  which  represents  the  entire  earnings  of  the  business 


INCOMES  AND  EXPENSES 


IS 


on  the  total  assets  invested.  The  difference  between  the  total 
income  and  the  interest  charges  represents  the  earnings  of  the 
proprietors  or  stockholders,  or  the  net  profits  of  the  business. 

4.  Deriving  the  Revenue  Statement  and  the  Balance  Sheet 
from  a  List  of  Items.  —  The  balance  sheet  shows  the  property 
items  which  a  business  owns  at  the  end  of  a  period,  and  the 
liability  and  proprietorship  items  for  which  the  business  is 
indebted  at  the  same  time.  The  revenue  statement  shows  in 
an  orderly  way  the  incomes  and  expenses  for  the  period  with 
the  net  profits  which  were  added  to  the  capital  of  the  begin- 
ning of  the  period  in  arriving  at  the  capital  shown  in  the  balance 
sheet  for  the  end  of  the  period.  Let  us  take  the  following  list 
of  items  and  derive  therefrom  a  revenue  statement  and  balance 
sheet  for  John  Smith  for  the  year  ending  December  31,  1918. 

LIST  OF  ASSETS  AND  EXPENSES,  INCOME  AND  LIABILI- 
TIES, FOR  JOHN  SMITH 
Year  Ending  December  31,  1918 


Asset  and 
Expense  Items 

Liability  and 
Incosie  Items 

Cash 

Accounts  Receivable 

Office  Furniture 

Notes  Payable 

Accounts  Payable 

John  Smith,  Capital 

Gross  Sales 

Returns  and  Allowances  on  Sales    . 
Interest  Received  on  Securities  Held    . 
Rent  Received  from  Tenant  of  Store 

Discounts  on  Purchases 

Merchandise  Inventory,  ist  of  Period  . 
Merchandise  Purchases  .      .      .      . 
Returns  and  Allowances  on  Purchases  . 

Salaries 

Advertising 

Rent 

Taxes    . 

General  Expense 

Interest  Paid 

Discounts  on  Sales 

5,000.00 
4,500.00 
1,200.00 

500.00 

5,000.00 
22,000.00 

5,000.00 
200.00 
500.00 
150.00 
200.00 
75.00 
150.00 

2,500.00 

6,500.00 

14,550.00 

20,000 .  00 

250.00 
100.00 
125.00 

400.00 

44,475.00 

44,475  00 

l6  ACCOUNTING  PRINCIPLES 

Merchandise  Inventory,  End  of  Period,  $18,600.00. 

JOHN  SMITH 
Revenue  Statement  For  Year  Ending  December  31,  19 18 

Gross  Sales  $20,000.00 

Less  Returns  and  Allowances  on 

Sales  500. 00  $19,500. 00 

Merchandise     Inventory,     ist  of 

Period  $5 ,000 .  00 

Merchandise  Purchases  $22 ,000 .  00 
Less  Returns  and  Al- 
lowances on  Pur.        400.00   21,600.00   26.600.00 


Deduct 

Merchandise  Inventory,  End  of  Period 

18.600.00 

Cost  of  Goods  Sold 

8,000.00 

Gross  Profits 

11,500.00 

Operating  Expenses 

Salaries 

5,000.00 

Advertising 

200.00 

Rent 

500.00 

Taxes 

150.00 

General  Expense 

200.00 

6.050.00 

Net  Profits  from  Operation 

S.450  00 

Other  income 

Interest  on  Securities  Held 

250.00 

Rent  from  Tenant  of  Store  Building 

150.00 

Discount  on  Purchases 

125  00  . 

52500 

Total  Income  5,975  00 

Deductions  from  Income 
Interest  75  co 

Discount  on  Sales  150.00        225.00 

Net  Profits  $5,750.00 


INCOMES  AND   EXPENSES  17 

JOHN  SMITH 
Balance  Sheet,  December  31,  1918 

Assets  LiahUities  and  Proprietorship 

Notes  Payable  $2,500.00 

Accounts  Payable  6,500.00 

Proprietorship 
John  Smith,  Capital  20,300 .  00 


Cash 

$5,000.00 

Accounts  Receivable 

4,500.00 

Merchandise    Inven- 

tory 

18,600.00 

Office  Furniture 

1,200.00 

$29,300.00 

$29,300.00 


If  John  Smith's  capital  of  $20,300.00  at  the  end  of  the 
period  be  compared  with  the  capital  of  $14,550.00  as  found  in 
the  Trial  Balance  it  will  be  observed  that  the  $5750.00  of  net 
profits  are  added  to  the  original  capital  item  to  produce  the 
final  capital  of  $20,300.00.  One  of  the  purposes  of  the  revenue 
statement  is  to  show  the  calculation  of  the  net  profit  item  to 
be  added  to  capital  before  the  balance  sheet  is  made. 

It  is  to  be  noted  that  the  gross  sales  item  is  not  an  asset  al- 
though $20,000.00  in  assets  come  into  the  business  in  connection 
with  the  $20,000.00  of  sales.  The  item  of  gross  sales  bears  a  rela- 
tion to  these  assets  similar  to  that  which  the  capital  item  bears 
to  cash  when  the  owner  of  the  business  invests  $10,000.00  of  cash. 
The  gross  sales  are  the  source  from  which  the  assets  are  re- 
ceived. The  items  which  follow  gross  sales  show  the  deduc- 
tions which  must  be  made  before  the  net  profit  can  be  derived 
and  added  to  the  capital  of  John  Smith  at  the  beginning  of  the 
period.  The  net  profit  of  S5750.00  represents  an  earning  of 
39^2%  oil  the  capital  of  John  Smith  at  the  beginning  of  the 
period.  It  represents  an  earning  of  19}^%  on  the  total  assets 
as  they  stood  at  the  end  of  the  period. 

5.  The  Use  of  the  Revenue  Statement.  —  Business  is  car- 
ried on  by  the  owners  mainly  for  the  net  profits  to  be  made, 
these  net  profits  representing  the  net  results  of  business  opera- 
tions so  far  as  the  owners  are  concerned.  These  net  profits 
may  be  added  to  the  investment  of  the  owners,  or  withdrawn 
from  the  business  for  other  uses.     If  left  in  the  business,  the 


1 8  ACCOUNTING  PRINCIPLES 

net  profits  produce  an  increase  of  capital  in  the  individual  or 
partnership  business  and  an  increase  of  surplus  in  the  corpo- 
rate form. 

The  revenue  statement  serves  to  show  to  the  owners  the 
profits  that  have  been  made  during  a  particular  period  and  the 
character  of  the  operations  that  have  produced  these  results. 
The  data  in  regard  to  expenses  furnish  information  that  is  ex- 
tremely useful  to  the  manager  in  making  future  plans.  He 
knows  what  services  have  been  secured  through  the  expense 
outlays,  and  will  strive  to  secure  the  same  service  at  a  lower 
cost  or  better  service  for  the  same  cost.  An  analysis  of  ex- 
penses, therefore,  provides  a  basis  for  the  formulation  of  a  busi- 
ness program  for  the  succeeding  period. 

Similarly,  an  analysis  of  the  gross  profits  is  useful  to  the 
manager  in  the  determination  of  his  future  selling  policy.  Dur- 
ing the  last  period,  the  gross  profits  have  been  a  certain  per 
cent  of  sales,  and  the  total  income  a  certain  per  cent  of  the 
total  assets.  If  this  return  on  the  total  investment  is  unsatis- 
factory, the  manager  will  strive  to  secure  a  larger  gross  profit 
from  sales,  so  as  to  increase  the  total  income. 

The  owners  of  a  business,  of  course,  are  mainly  interested  in 
making  the  net  profits  as  large  a  percentage  as  possible  of  their 
own  capital  investment.  If  this  return  is  unsatisfactory,  the 
owners  will  either  endeavor  to  increase  the  net  earnings  or 
transfer  their  investment  to  some  other  enterprise  in  which 
larger  financial  returns  may  be  secured. 

6.  Complications  and  Omissions.  —  From  the  foregoing  state- 
ment, there  have  been  purposely  omitted  the  many  complica- 
tions arising  in  connection  with  its  construction.  These  will  be 
considered  in  their  due  order.  Likewise,  there  has  been  post- 
poned a  consideration  of  many  of  the  uses  of  the  revenue  state- 
ment in  connection  with  the  balance  sheet.  The  statement  as 
presented  will  suffice  for  an  introductory  treatment  of  the  prin- 
ciples of  double-entry  bookkeeping  and  accounting 


INCOMES  AND  EXPENSES 


19 


PROBLEMS  AND  QUESTIONS 

I.  In  the  following  statement,  the  items  in  the  first  column  are  either 
expenses  or  assets;  the  items  in  the  second  column  are  income,  liabilities, 
and  proprietorship.  From  these  items,  make  out  a  revenue  statement  and 
a  balance  sheet. 

In  solving  this  problem,  make  out  the  revenue  statement  first,  add  the 
net  profits  to  the  capital,  and  then  make  out  the  balance  sheet. 

To  find  the  cost  of  the  goods  sold,  to  be  deducted  from  sales  to  ascertain 
the  gross  profits,  deduct  the  merchandise  on  hand  from  the  purchases. 

June  30,  1919 


Cash 

Notes  Receivable  . 
Accounts  Receivable   . 
Furniture  and  Fixtures 
Notes  Payable 
Accounts  Payable  . 
J.  C.  Kenedy,  Capital 

Sales 

Discount  on  Purchases 
Purchases    .... 
Expenses     .... 
Discount  on  Sales  . 
Interest       .... 


Assets  and 
Expenses 


[2,257.35 

588.00 

800 . 00 

1,175.00 


17,000.00 

1,641 .00 

132.00 

60.3s 


$33,653-70 


labilities, 

Income  and 

Proprietorship 


$7,250.00 

3,150.00 

1 1 ,000 . 00 

12,025.50 

228.20 


$33.653 -70 


Merchandise  on  hand  June  30,  $9074 .  50. 

2.  What  does  the  revenue  statement  in  Problem  i  show  to  have  been 
earned  (a)  on  total  assets  at  the  beginning  of  the  period;  (b)  on  capital  at 
the  beginning  of  the  period? 

3.  What  per  cent  of  sales  are  the  gross  profits  of  Problem  i?  Of  what 
value  is  this  information  to  the  manager  or  the  owner  of  the  business? 

4.  Explain  .the  difference  between  balance  sheet  and  revenue  items. 

5.  From  the  following  statement,  make  out  a  revenue  statement  and  a 
balance  sheet,  as  in  Problem  i. 

Make  out  the  revenue  statement  first,  add  half  of  the  net  profits  to  the 
capital  item  of  William  Henderson  and  half  to  the  capital  item  of  John 
Perry,  and  then  make  out  the  balance  sheet,  showing  the  assets,  liabilities 
and  proprietorship. 


20 


ACCOUNTING  PRINCIPLES 
April  i,  iqis-March  30.  1913 


Assets  and 
Expenses 

LlABnjTIES, 

Income  and 
Proprietorship 

Cash 

Notes  Receivable 

Accounts  Receivable 

Office  Furniture 

Notes  Payable 

Accounts  Payable 

William  Henderson,  Capital    .... 

John  Perry,  Capital 

Sales 

Sales  Returns 

Discount  on  Purchases 

Mdse.  Inv.,  First  of  Period      .... 

54.376.50 
4,000.00 
7,000.00 
1,350.00 

400.00 

2,500.00 
18,000.00 

1,200.00 
2,000.00 
3,600.00 
2,000.00 
1,300.00 
60.00 

2,500.00 
3,800.00 
4,800.00 
5,000.00 
31,181.50 

180.00 

Returned  Purchases 

Rent 

Selling  Expenses  —  Office 

General  Expense 

Salesmen's  Salaries 

Salaries  —  Office 

Interest  —  Discount  on  Notes. 

32500 

$47,786.50 

$47,786.50 

Merchandise  on  hamd  March  30,  1913.  $6,280.00. 

6.  Suppose  that  instead  of  the  two  items  of  William  Henderson,  Capital, 
and  John  Perry,  Capital,  there  was  one  item  of  Capital  Stock,  $9,800.00; 
how  would  the  proprietorship  item  appear  in  the  balance  sheet? 


CHAPTER  III 
THE  ACCOUNTS  AND  THEIR  RELATION  TO  THE  STATEMENT 

1.  Relation  of  Accounts  to  Statements.  —  The  balance  sheet 
and  the  revenue  statement  given  in  Chapter  II  contain  the 
items  most  frequently  used  as  the  names  of  accounts  in  double- 
entry  bookkeeping.  The  amount  of  property  represented  at 
any  time  by  an  asset  item  or  asset  account  is  called  the  balance 
of  the  account.  Likewise,  the  amount  of  liability  represented 
at  any  time  by  a  liability  item  or  liability  account  is  called  the 
balance  of  the  account.  The  same  definition  holds  true  for  the 
income  and  the  expense  items.  Their  amounts  at  a  particular 
time  represent  the  balances  of  the  accounts  by  the  same  names 
as  the  names  of  the  items. 

2.  Periods  Covered  by  Accounts.  —  Whenever  it  becomes  de- 
sirable to  make  a  revenue  statement  or  a  balance  sheet,  it  is 
necessary  to  calculate  new  balances  for  the  accounts.  These 
new  balances,  in  the  case  of  asset  and  liability  accounts,  show 
what  the  business  unit  owns  and  owes  at  the  time  the  balances 
are  taken.  In  the  case  of  the  revenue  accounts,  they  show 
what  the  income  and  the  expenses  have  been  during  the  period 
covered  by  the  accounts.  Af  cer  a  balance  sheet  and  a  revenue 
statement  have  been  made,  the  accounts  are  reopened,  and  a 
new  period  of  operation  is  begun.  The  time  elapsing  between 
the  opening  and  closing  of  the  accounts  represents  the  period 
covered  by  the  revenue  statement,  as  well  as  the  period  cov- 
ered by  the  various  accounts. 

3.  Transactions  and  Balance  Changes.  —  In  double-entry 
bookkeeping,  each  transaction  changes  the  balance  of  at  least 

.  two  accounts.  In  describing  an  account,  however,  it  is  simpler 
to  point  out  how  a  particular  transaction  affects  it,  without 
noting  how  some  other  account  is  affected  at  the  same  time. 
Let  us,  therefore,  take  some  of  the  simpler  accounts. 


22 


ACCOUNTING  PRINCIPLES 


4.  Customer  Accounts,  or  Accounts  Receivable.  —  The  cus- 
tomer accounts  arise  from  the  sale  of  goods  to  customers  on 
time.  When  an  article  is  sold  to  a  customer  on  credit,  he  be- 
comes indebted  to  the  business,  and  his  account  is  debited. 
When  the  customer  pays  any  or  all  of  the  debt,  his  account  is 
credited  with  the  amount  of  the  debt  thus  canceled.  In  other 
words,  the  account  is  debited  when  a  transaction  arises  to  in- 
crease the  net  amoimt  of  the  debt,  and  is  credited  when  a 
transaction  arises  to  decrease  the  net  amount  of  this  indebted- 
ness. The  debit  balance,  therefore,  is  the  balance  of  the  debt 
still  imp)aid,  and  may  be  found  by  subtracting  the  total  cred- 
its from  the  total  debits,  as  indicated  in  Illustration  No.  i, 
below.  All  debit  items  are  placed  on  the  left  side  of  the 
account  and  all  credit  items  are  placed  on  the  right.  All  asset 
balances  are  debit  balances  by  definition  and  all  liability  and 
proprietorship  balances  are  credit  balances  by  definition. 

ILLUSTR.\TION   NO.  i 

An  Account  with  a  Customer 

John  SwrrH 


I9I8 

1918 

Jan. 

I 

350 

00 

Jan. 

S 

a  38 

00 

2 

75 

00 

6 

350 

00 

3 

28 

75 

7 

a  34 

25 

4 
II 

103.75 

2/10,  n/30 

Balance 

=_ 

a72 

25 

10 

Balance* 

423 
103 

75 

St6 

526 

00 
00 

526 

00 
00 

Jan. 

103 

75 

Jan. 

IS 

103 

75 

I9I8 

Jan.     I     Sold  to  John  Smith  merchandise  amounting  to  $350.00. 

2  Sold  on  account  merchandise  amounting  to  $75.00. 

3  Sold  on  account  merchandise  amounting  to  $28.75. 

4  Sold  on  30  days'  time,  2%  10  dajrs,  merchandise  amounting 

to  $72.25. 

'  The  whole  line  is  written  in  red  ink. 
counts  represents  red  ink. 


Throughout  the  book  black-face  type  in  ac- 


ACCOUNTS,  THEIR  RELATION  TO  STATEMENT         23 

Memoranda  of  cash  discounts  should  be  inserted  in  the 
memorandum  space,  as  in  Illustration  No.  i. 
Jan.     5    Received  on  account  of  bill  of  Jan.,  $38.00. 

The  fact  that  the  receipt  of  Jan.  5  is  to  be  applied  to  the 
sale  of  Jan.  4  is  indicated  by  inserting  the  same  small 
letter  before  both  items,  as  in  Illustration  No.  i. 

6  Received  on  account,  $350.00. 

7  Received  on  account  the  balance  of  the  bill  of  Jan.  4,  $34.25. 

8  Bill  is  sent  to  the  customer  for  $103.75. 

No  entry  is  made  of  this  action,  but  the  debit  balance  is 

entered  in  small  pencil  figures  to  the  left  of  the  last 

debit  item. 
5    Received  $102.30  in  full  settlement  of  the  account,  $1.25 

being  allowed  as  a  discount. 
A  single  red  line  is  drawn  under  the  debits  and  credits 

after  the  transaction  is  entered,  thus  indicating  that 

the  account  was  settled  on  Jan.  15. 

The  name  of  the  customer  is  written  at  the  head  of  the  ac- 
count, and  becomes  the  name  of  the  account.  The  total  of  the 
debits  is  set  down  in  small  pencil  figures  below  the  last  debit, 
and  the  total  of  the  credits  in  like  manner  below  the  last  credit. 
Since  the  debits  are  usually  greater  than  the  credits,  the  bal- 
ance of  the  account  is  ordinarily  a  debit  balance,  and  is  written 
in  small  pencil  figures  to  the  left  of  the  last  debit  item.  If  the 
customer  should  overpay  his  account,  the  credits  would  be 
greater  than  the  debits,  and  the  balance  of  the  account,  which 
in  such  an  instance  would  be  a  credit  balance,  would  be  ini- 
tially entered  in  the  same  manner  as  the  debit  balance  to  the 
left  of  the  last  credit  item. 

EXERCISE  NO.  i 
John  King 

On  a  sheet  of  ledger  paper,  prepare  an  account  for  John  King 
similar  to  that  prepared  for  John  Smith  in  Illustration  No.  i.    Ledger 
paper  has  a  ruling  like  the  ruling  in  Illustration  No.  i. 
1918 
Feb.    I    Balance  due  from  John  King,  $85.25. 

The  balance  of  a  debt  used  in  opening  an  account  is 
entered  on  the  debit  side,  just  as  the  amount  of  each 
transaction  increasing  the  debt. 
2     Sold  on  account  merchandise  amounting  to  $45.30. 


24  ACCOUNTING  PRINCIPLES 

Feb.    3    Allowed  a  credit  of  $2.00  for  damaged  goods. 

4  Received  $85.25  in  payment  of  the  balance  due  at  the  be- 

ginning of  the  month. 

5  Sold  on  accoimt  merchandise  amounting  to  $35.75. 

6  Received  a  note  for  $79.05  in  settlement  of  balance  of 

account. 

A  note  is  treated  as  cash  in  making  credits  to  a  customer's 
account.  It  is  true  that  the  customer  still  owes  the 
amount  of  the  note,  but  the  record  of  the  debt  is  made 
in  the  accoimt  Notes  Receivable,  to  be  explained  later. 

When  an  account  is  settled  prior  to  the  date  of  closing 
the  books,  a  red  line  is  drawn  underneath  the  last 
debit  and  the  last  credit  item,  thus  indicating  that  the 
accoimt  was  balanced  on  the  pjarticular  date. 

7  Sold  on  30  days'  time,  2%  10  days,  goods  amounting  to 

S75.50,  and  charged  $1.25  for  drayage. 

8  Sold  on  account  merchandise  amounting  to  $20.00,  and 

received  on  account  poultry  valued  at  $2.50. 

9  Received  payment  for  the  goods  sold  on  the  7th,  less  the 

discount. 
10    Calculated  the  balance  due,  sent  out  bill,  and  closed  the 

account. 
1 5     Received  the  amount  of  the  bill  rendered. 

Summary  of  Accounts  with  Customers 

Debil  Customers  Credit  Customers 

1.  For  the  amount  due  at  the  4.  For  all  cash  paid  on  ac- 
time  of  opening  the  account.  count. 

2.  For  the  price  of  all  goods  5.  For  all  notes  given  to  ap>- 
sold  on  time.  ply  on  account. 

3.  For  all  sundry  charges,  6.  For  all  allowances  made 
such  as  freight,  drayage,  etc.  for  damages,  shortages,  defective 

goods,  etc. 

7.  For  all  cash  discounts  al- 
lowed. 

8.  For  the  balance  of  the  ac- 
count when  it  is  decided  to  be  un- 
collectible or  the  account  is  closed. 

The  detailed  description  of  the  customer  accounts  is  in- 
tended to  show  the  form  in  which  the  record  of  the  changes  in 
the  balances  is  kept.  The  principle  involved,  however,  may  be 
stated  very  simply.  The  customer  accounts  are  property  or 
asset  accounts.    Consequently,  the  balances  are  debit  balances 


ACCOUNTS,  THEIR  RELATION  TO  STATEMENT         25 


until  they  begin  to  show,  not  the  amount  of  this  form  of  prop- 
erty that  the  business  owns,  but  the  amount  that  the  business 
owes.  If  a  transaction  with  a  customer  increases  his  debt  or 
the  original  debit  balance,  his  account  is  debited  with  the 
amount  of  this  increase.  If  the  transaction  decreases  his  debt, 
his  account  is  credited  with  the  amount  of  the  decrease.  Thus, 
the  account  becomes  a  record  of  the  changes  in  the  initial  bal- 
ance of  the  account,  the  first  transaction  or  the  opening  entry 
representing  this  initial  balance. 

5.  Cash  Accounts.  —  The  meaning  of  debits  and  credits  in 
the  cash  accoimt  is  essentially  the  same  as  the  meaning  of  these 
terms  in  the  customer  accounts  described  above,  although  the 
idea  of  debt  does  not  enter  into  the  cash  account.  Cash  is,  of 
course,  an  asset  account.  When  cash  is  received,  the  amount 
of  this  asset  is  increased,  and  the  account  is  debited.  When 
cash  is  paid  out,  this  particular  asset  is  decreased,  and  the  ac- 
count is  credited.  In  other  words,  cash  sales  increase,  whereas 
cash  outlays  decrease,  the  cash  asset. 

Since  the  cash  account  is  an  asset  account,  the  balance  is  a 
debit  balance,  and  shows  the  amount  of  cash  on  hand.  In  com- 
mon with  other  asset  balances,  the  cash  balance  is  required  if  a 
balance  sheet  is  to  be  made  showing  the  condition  of  the  busi- 
ness 

ILLUSTRATION  NO.  2 

The  Cash  Account 
Cash 


I9I8 

1918 

Jan. 

I 

5000 

00 

Jan. 

2 

50 

00 

4 

44S4S0 

225 
sens 

00 
00 

3 
5 
6 

7 

350 

8S 

250 

35 
770 

00 

CX) 

00 

50 
50 

9 

Balance 

= 

Balance 

== 

4454 

50 

5225 

00 

5225 

00 

Jan. 

4454 

50 

26  ACCOUNTING  PRINaPLES 

1918 

Jan.     I  J.  R.  Wall  invests  in  business  $5,cxx>.oo. 

2  The  business  paid  $50.00  for  rent. 

3  Paid  $350.00  for  merchandise. 

4  Received  $225.00  for  merchandise  cash  sales. 

5  Purchased  coal  for  $85.00  cash. 

6  Paid  $250.00  to  J.  R.  Smith. 

7  Paid  sundry  expenses  amounting  to  $35.50. 

EXERCISE  NO.  2 

1918 

Feb.    I  C.  H.  Johnson  invested  $3500.00  in  business. 

2  Paid  for  rent,  $75.00;  for  salaries,  $65.00. 

3  Received  on  a  note,  $2500.00. 

4  Purchased  goods  for  $750.00  cash. 

5  Received  $3500.00  for  cash  sales. 

6  Paid  C.  R.  Rendles  check  for  $250.00. 

7  Balanced  and  closed  the  account. 

6.  Other  Asset  Accounts.  —  If  the  principle  of  debits  and 
credits  for  property  or  asset  accounts  is  fully  understood  from 
the  customer  and  cash  accounts,  it  is  hardly  worth  while  to  dis- 
cuss in  detail  the  other  property  accounts.  It  is  clear,  for  ex- 
ample, that  a  purchase  of  furniture  and  fixtm-es  would  increase 
the  amount  of  this  form  of  property,  and  should  consequently 
be  debited  to  the  account.  If  an  item  of  furniture  and  fixtures 
is  removed  or  destroyed,  how^ever,  the  balance  of  the  account 
would  be  decreased  by  the  cost  of  the  item,  and  the  account 
should  be  credited  by  that  amount.  The  various  complications 
that  frequently  arise  in  connection  with  prop)erty  accounts  need 
not  concern  us  for  the  present. 

7.  Creditor  Accounts,  or  Accounts  Payable.  —  Creditor  ac- 
counts are  kept  by  a  business  with  those  from  whom  purchases 
are  made.  The  buying  of  goods  on  time  from  an  outside  party 
results  in  a  credit  to  the  one  from  whom  the  goods  are  received, 
just  as  in  the  case  of  the  payment  by  an  individual  of  cash  on 
his  account.  The  payment,  on  the  other  hand,  by  the  business 
to  the  creditor  of  all  or  part  of  the  obligation  incurred  results  in 
a  debit  to  the  account.  In  other  words,  the  creditor  is  credited 
for  the  price  of  the  goods  turned  over  to  the  business,  and  is 
debited  for  all  paj-ments  by  the  business  for  the  goods  received. 


ACCOUNTS,  THEIR  RELATION  TO  STATEMENT 


27 


The  balance  of  a  creditor  account  is  generally  a  credit  bal- 
ance, and  is  therefore  initially  entered  in  small  pencil  figures  to 
the  left  of  the  last  credit  item. 


ILLUSTRATION  NO.  3 

An  Account  with  a  Creditor 

Haywood  Bros. 


I9I8 

1918 

Jan. 

3 

300 

00 

Jan. 

I 

4 

225 

00 

2 

5 

7 

Note  $125 
30  days 
Balance 

125 

00 

6 

650 
365 

00 
00 

1015 

00 

I9I8 

Jan. 


2/10 


365.00 


425 

225 
650 
35° 

IS 

1015 


Bought  of  Haywood  Bros,  goods  amounting  to  $425.00. 

Bought  merchandise  amounting  to  $225.00,  2%  10  days. 

Paid  on  invoice  of  Jan.  i,  $300.00. 

Paid  invoice  of  Jan.  2,  taking  the  discount. 

Settled  balance  of  bill  of  Jan.  i  by  note  for  $125,  30  days. 

Bought  merchandise  to  the  amount  of  $350.00,  Haywood 

Bros,  agreeing  to  advance  the  freight.     Bill  rendered 

for  freight  charges,  $15.00. 
Calculated  balance  due  to  verify  bill  received,  and  closed 

the  account. 


EXERCISE  NO.  3 

Kidder  &  Morse 

On  a  sheet  of  ledger  paper,  prepare  an  account  for  Kidder  &  Morse 
similar  to  that  prepared  for  Haywood  Bros,  in  Illustration  No.  3. 

1918 
Mar. 


Balance  due  Kidder  &  Morse,  $455.20. 

Bought  on  30  days'  time  goods  amounting  to  $225.00. 

Bought  on  30  days'  time,  3%  10  days,  goods  amounting  to 

$130.00. 
Paid  invoice  of  $235.00  and  freight  of  $40.50,  the  latter 

being  charged  to  their  account. 


28  ACCOUNTING  PRINCIPLES 

Mar.   5  Paid  invoice  of  Mar.  3,  less  the  discount. 

6  Gave  a  30-day  note  for  the  balance  of  the  account. 

7  Bought  merchandise  to  the  amount  of  $325.00. 

8  Received  allowance  of  $25.00  for  damaged  goods. 

9  Paid  on  account,  $125.00,  and  closed  the  account. 

Summary  of  Accounts  with  Credtfors 

Debit  Creditors  Credit  Creditors 

1.  For  all  cash  paid  them  on  6.  For  amount  due  them  at 
accoimt.                                               the  time  of  opening  the  account. 

2.  For  all  notes  given  them  7.  For  the  price  of  all  mer- 
on  account.                                         chandise  bought  on  time. 

3.  For  all  rebates  allowed  by 
them  on  account. 

4.  For  all  freight  charges  paid 
on  goods  to  be  deUvered  f.o.b. 
destination. 

5.  For  all  cash  discoimts. 

As  in  the  case  of  the  customer  accounts,  a  rather  detailed  de- 
scription of  the  creditor  accounts  is  necessary  to  illustrate  cor- 
rect form  and  the  operation  of  the  principle  involved.  The 
principle  itself  may,  however,  be  very  briefly  stated.  A  cred- 
itor account  is  a  liability  account,  and  the  balance  is,  therefore, 
a  credit  balance  so  long  as  the  accoimt  remains  a  liability  ac- 
count. In  other  words,  the  balance  shows  what  the  business 
owes  rather  than  what  it  owns.  If  a  transaction  increases  the 
amount  due  the  creditor,  the  account  is  credited  with  the 
amount  of  such  increase.  If  a  transaction  results  in  decreasing 
the  amount  due  the  creditor,  the  account  is  debited  with  the 
amount  of  such  decrease.  The  purpose  of  the  account  is  so  to 
record  the  items  affecting  it  that  the  balance  due  the  creditor 
may  be  found  at  any  time,  for  no  balance  sheet  showing  the 
condition  of  the  business  can  be  made  unless  the  liabilities  are 
correctly  stated. 

8.  Other  Liability  Accounts.  —  The  foregoing  discussion  and 
illustrations  lead  to  a  statement  of  the  basic  assumption  of 
double-entry  bookkeeping.  This  assumption  is  that  assets  or 
asset  balances  are  debit  balances  and  that  liabilities  or  liability 
balances  together  with  proprietorship  balances  are  credit  bal- 


ACCOUNTS,   THEIR  RELATION  TO  STATEMENT         29 

ances,  with  an  initial  equality  of  debits  and  credits,  since  assets 
equal  the  liabilities  plus  proprietorship.  The  other  principles 
of  debit  and  credit  follow  as  a  matter  of  course,  the  rest  of 
double-entry  bookkeeping  being  concerned  largely  with  a  proper 
record  of  the  changes  in  the  asset,  liability  and  proprietorship 
balances. 

The  reason  for  designating  as  credits  the  debts  a  business 
owes  to  its  creditors  is  probably  found  in  the  application  of 
the  term  good  credit  to  the  ability  of  a  business  to  buy  on  time. 
If  the  credit  balance  of  one  liability  is  designated  as  a  credit,  it 
follows  in  a  general  system  of  debits  and  credits  that  other  lia- 
bility balances  should  also  be  designated  as  credits.  Inasmuch 
as  assets  are  the  opposite  of  liabilities  from  the  standpoint  of 
business  ownership,  asset  balances  must,  of  course,  be  debit 
balances. 

9.  Revenue  Accounts.  —  The  general  principle  of  debits  and 
credits  applies  also  to  the  revenue  accounts,  which  involve  both 
expense  and  income  accounts.  All  income  items  result  in  an 
increase  of  capital  or  proprietorship  interest,  and  are  therefore 
credits  to  the  capital  account.  For  the  purpose  of  simplifying 
the  appearance  of  the  capital  account,  however,  the  income 
and  expense  accounts  are  kept  separately,  and  finally  closed 
into  the  profit  and  loss  account,  which  serves  as  a  temporary 
capital  account.  The  profit  and  loss  balance  is  eventually  carried 
to  the  permanent  capital  account  as  a  debit  or  credit  balance. 

The  revenue  accounts,  the  profit  and  loss  account,  and  the 
capital  account  will  be  considered  further  after  a  discussion  of 
the  merchandise  account. 

ID.  The  Merchandise  Account.  —  At  first  thought,  this  ac- 
count may  seem  an  ordinary  property  account.  The  purchase 
of  merchandise  results  in  an  increase  in  the  amount  of  this 
form  of  property,  and  is  therefore  a  debit  to  the  merchandise 
account.  The  sale  of  merchandise,  on  the  other  hand,  results 
in  a  decrease  in  the  amount  of  goods  on  hand,  and  is  therefore 
a  credit  to  the  merchandise  account.  The  general  principle  of 
debits  and  credits  applies,  then,  just  as  in  the  cash  acpount. 

There  are  two  fundamental  differences,  however,  between  the 


30  ACCOUNTING  PRINCIPLES 

merchandise  account  and  the  other  asset  accounts,  (i)  Mer- 
chandise is  ordinarily  not  sold  at  the  purchase  price;  conse- 
quently, a  subtraction  of  the  credits  from  the  debits  does  not 
show  the  balance  of  merchandise  on  hand.  (2)  A  gain  is  made 
when  goods  are  sold  above  cost,  resulting  in  an  increase  of  the 
capital  or  proprietorship  interest  of  the  owners;  consequently,  a 
record  should  be  made  to  show  the  obligation.  It  is  necessary, 
therefore,  for  the  merchandise  account  to  show  two  balances, 
one  being  the  balance  of  merchandise  on  hand,  the  other  the 
gain  on  merchandise.  The  merchandise  balance  is  always  the 
opening  balance  of  the  merchandise  account  for  the  succeeding 
I)eriod,  while  the  gain  on  merchandise  is  carried  to  the  credit 
of  profit  and  loss,  which  has  already  been  described  as  a  tem- 
porary capital  account. 

These  balances  can  be  readily  secured,  the  first  by  listing  at 
cost  the  unsold  items  of  merchandise,  the  second  by  using  the 
first  in  connection  with  the  debits  and  credits  to  the  merchan- 
dise account.  The  total  of  the  debits  to  merchandise  repre- 
sents the  cost  of  the  goods  on  hand  at  the  beginning  of  the 
period  plus  the  cost  of  purchases  made  during  the  period.  If 
from  this  total  there  is  subtracted  the  cost  value  of  the  mer- 
chandise on  hand,  the  difference  represents  the  cost  of  the  goods 
sold.  If  we  now  regard  the  cost  of  the  goods  sold  as  the  total 
debits  and  sales  as  the  total  credits,  the  credit  balance  discloses 
the  gain  on  merchandise. 

The  same  result  is  secured  more  conveniently,  however,  by 
taking  credit  in  the  merchandise  account  for  the  merchandise 
on  hand,  or  the  merchandise  inventory  at  the  end  of  the  period. 
The  credits  then  become  the  sales  at  the  sale  price  and  the 
cost  value  of  the  goods  on  hand  at  the  close  of  the  period.  The 
debits  become,  as  formerly,  the  cost  of  the  merchandise  on 
hand  at  the  beginning  of  the  period,  the  cost  of  the  purchases 
made  during  the  f)eriod,  and  the  balance  again  represents  the 
gain  on  merchandise.  The  merchandise  inventory  is  entered  in 
red  on  the  credit  side  of  the  account  as  the  debit  balance,  and 
is  brought  down  as  the  beginning  balance  for  a  new  period. 
The  gain  on  merchandise  is  entered  as  a  credit  balance  on  the 


ACCOUNTS,  THEIR  RELATION  TO  STATEMENT    3 1 


debit  side  of  the  account,  the  entry  being  in  red  if  the  account 
is  not  closed  through  the  journal,  but  in  black  if  the  account  is 
closed,  as  is  ordinarily  done,  through  a  journal  entry.  This 
matter  of  closing  will  be  discussed  later  on. 

Because  of  the  presence  of  the  two  balances  indicated  above,  the 
one  a  debit  or  asset  balance,  the  other  a  credit  or  proprietorship 
balance,  the  merchandise  is  frequently  called  a  mixed  account, 
or  a  mixture  between  an  asset  and  a  proprietorship  account. 

ILLUSTRATION  NO.  4 

The  Merchandise  Account 

Merchandise 


I9I8 

1918 

Jan. 

2 

77 

30 

Jan. 

4 

14 

25 

3 

134 

95 

6 

30 

00 

5 

192 

00 

8 

57 

35 

10 

228 

60 

II 

54 

25 

15 

246 

00 

13 

40 

00 

17 

28 

00 

52 

40 

23 

197 

10 

16 

49 

40 

27 
31 

Gross 
Profit 

172 
1276 
262 

75 
70 
81 

51 

19 
22 

25 
26 
27 

31 

Bal.-Inv. 

42 
50 
24 
80 
78 
42 

42 

657 
882 

30 

00 

05 

05 

25 

25 

50 
05 
46 

1539 

J  539 

St 

I 

Inventory 

= 

1539 

51 

= 

1539 

51 

Feb. 

882 

46 

32  ACCOUNTING  PRINCIPLES 

1918 

Jan.    2    Bought   from   Benson   &    Co.   on   account   merchandise 
amounting  to  $77.30. 

3  Bought  from  Reynolds  Bros,  on  account  merchandise  to 

the  amount  of  $134.95. 

4  Sold  to  B.  C.  Judson  on  account  merchandise  of  the  value 

of  $14.25. 

5  Bought  from  the  Valley  Flour  Company  for  cash  mer- 

chandise amounting  to  $192.00. 

6  Cash  sales  of  merchandise,  $30.00. 

8    Sold  to  Adolph  Hudson  on  account  goods  amounting  to 

$57-35- 

10  Bought  from  J.  D.  Lowrey  merchandise  to  the  amoimt  of 

$228.60. 

11  Sold  to  B.  C.  Judson  merchandise  amounting  to  $54.25. 

13     Cash  sales  of  merchandise,  $40.00;  sold  to  R.  E.  Johns 
goods  to  the  amoimt  of  $52.40. 

15  Bought  from  Benson  &  Co.  merchandise  to  the  amount  of 

$246.00. 

16  Sold  to  E.  R.  Hutchins  merchandise  amounting  to  $49.40. 

17  Bought  from  the  Model  Creamery  merchandise  amounting 

to  $28.00. 
19    Sold  to  A.  C.  Williams  merchandise  amounting  to  $42.30. 

22  Cash  sales  of  merchandise,  $50.00;  sold  to  R.  G.  Mathews 

merchandise  to  the  amount  of  $24.05. 

23  Bought  from  J.  A.  Smith  goods  amounting  to  $197.10. 

25  Sold  to  E.  R.  Hutchins  on  account  merchandise  amounting 

to  $80.05. 

26  Sold  to  C.  L.  White  on  accoimt  goods  to  the  amoimt  of 

$78.25. 

27  Bought    from    Benson    &    Co.    on   account   merchandise 

amounting  to  $172.75;  sold  to  B.  C.  Judson  on  account 
'  goods  to  the  amount  of  $42.25;  cash  sales,  $42.50. 

31    Inventory  of  goods  on  hand,  $882.64. 

II.  Profit  and  Loss  Accoiut.  —  This  accoimt  is  discussed  be- 
fore the  capital  account  because  it  is  what  may  be  termed  the 
temporary  capital  account.  By  means  of  it,  all  the  operating 
charges  and  credits  to  capital  are  gathered  together,  so  that 
only  the  balance  of  loss  or  gain  for  a  given  period  may  go  to 
the  debit  or  credit  of  the  capital  account.  The  profit  and  loss 
account  is,  consequently,  a  proprietorship  account.  It  differs 
from  the  capital  account  only  in  that  the  net  balance,  called  net 


ACCOUNTS,  THEIR  RELATION  TO  STATEMENT         33 

profits,  shows  what  the  business  is  due  the  owners  for  a  par- 
ticular period  of  operation,  whereas  the  capital  account  shows 
the  total  obligation  of  the  business  to  the  owners. 

Although  temporary  in  nature,  the  profit  and  loss  account 
does  not  contain  a  detailed  record  of  operating  charges  and 
credits.  These  charges  and  credits  are  much  more  advan- 
tageously kept  in  separate  accounts.  It  is  extremely  impor- 
tant that  the  manager  of  the  business  know  not  only  the  total 
income  and  the  total  expense,  but  the  amount  of  the  various 
classes  of  each.  By  means  of  such  information,  new  selling 
plans  may  be  formulated  and  excessive  expense  in  any  particular 
direction  may  be  reduced.  At  the  end  of  the  operating  period, 
the  accounts  are  closed,  and  the  totals  of  the  expense  accounts 
and  the  totals  of  the  income  accounts  are  carried  over  to  profit 
and  loss,  the  former  as  debit  and  the  latter  as  credit  balances. 

Few  explanations  are  inserted  in  the  ordinary  account  to 
show  how  the  items  arose.  This  is  not  true,  however,  of  the 
profit  and  loss  account.  The  names  of  all  expense  accounts,  as 
well  as  the  names  of  all  income  accounts,  that  are  closed  into 
profit  and  loss  are  placed  opposite  the  balances  of  these  ac- 
counts as  they  appear  in  profit  and  loss.  The  most  common 
income  accounts  are  gain  from  merchandise,  interest  received, 
rent  received,  income  from  outside  operations,  and  miscellane- 
ous income.  The  classes  of  operating  expense  have  already 
been  indicated  in  the  previous  chapter.     (See  p.  41.) 

12.  Capital  Account.  —  The  principles  of  debit  and  credit  de- 
scribed for  the  profit  and  loss  account  apply  also  to  the  capital 
account,  the  credit  balance  of  which  at  the  beginning  of  a 
period  represents  the  investment  or  proprietorship  interest  of 
the  owners  at  that  time.  Instead  of  being  credited  or  debited 
directly  to  the  capital  account,  subsequent  increases  or  de- 
creases in  this  investment  or  proprietorship  interest  are  closed 
out  first  into  profit  and  loss.  At  the  end  of  the  period,  the  net 
balance  of  the  profit  and  loss  is  credited  to  the  capital  account 
if  the  account  shows  a  credit  balance  or  net  profit.  If  the  ac- 
count shows  a  debit  balance  or  loss,  it  is  carried  to  the  debit  of 
the  capital  account. 


34  ACCOUNTING  PRINCIPLES 

There  are  sometimes,  however,  exceptional  items  of  gain  or 
loss,  such  as  profits  arising  from  the  sale  of  the  premises  on 
which  the  business  is  carried  on,  or  losses  from  fire  and  other 
like  causes.  Such  exceptional  items  are  closed  out  directly  into 
the  capital  account.  By  thus  eliminating  from  profit  and  loss 
the  exceptional  items  of  gain  or  loss,  the  balance  of  the  account 
is  made  to  show  the  profit  or  loss  from  the  regular  operations 
of  the  business.  One  can  then  compare  the  profits  of  one 
period  with  those  of  another  and  reach  a  fair  conclusion  as  to 
whether  the  business  is  more  successfully  conducted  in  any 
p)eriod  than  it  was  in  a  preceding  period.  Occasionally,  there 
are  also  corrections  resulting  from  readjustments  in  asset  values. 
Changes  in  proprietorship  interest  from  these  sources  are  first 
charged  or  credited  to  an  adjustment  account,  which  in  turn  is 
closed  into  capital,  instead  of  into  profit  and  loss.     (See  p.  41.) 

13.  Personal  Account.  —  In  an  individual  or  partnership 
business,  money  and  goods  are  frequently  withdrawn  by  the 
owner  or  owners  for  personal  use.  Such  withdrawals  decrease, 
of  course,  the  capital  investment,  and  consequently  become  a 
debit  to  the  capital  account.  The  items  are,  however,  first 
recorded  in  a  separate  personal  account,  and  closed  into  the 
capital  account  when  a  balance  sheet  or  revenue  statement  is 
made.  Payment  of  a  part  or  all  of  the  debt  at  any  time  before 
the  closing  of  the  personal  account  becomes  a  credit  to  the  ac- 
count, the  net  balance  representing  the  amount  of  capital  in- 
vestment withdrawn  during  the  period  under  consideration.  If 
the  net  balance  should  perchance  be  a  credit  balance,  it  be- 
comes a  credit  to  the  capital  account.  Ordinarily,  the  balance 
is  a  debit  balance,  and  becomes  a  charge  against  the  capital  or 
proprietorship  interest  of  the  business.     (See  p.  40.) 

14.  Accounts  Affected  by  a  Transaction.  —  From  the  stand- 
point of  debits  and  credits,  there  are  two  classes  of  accounts, 
assets  and  claims  against  assets,  or  things  which  the  business 
owns  and  things  which  it  owes  to  the  holders  of  liabilities  and 
the  owners  of  the  proprietary  interest.  Moreover,  in  the  be- 
ginning there  is  an  equality  of  debits  and  credits,  the  total  of 
the  things  owned  being  equal  to  the  total  of  the  things  owed. 


ACCOUNTS,   THEIR  RELATION  TO  STATEMENT         35 

Subsequent  business  exchanges  result  in  a  readjustment  of  the 
various  debits  and  credits,  but  do  not  affect  the  equality  of 
their  totals.  Thus,  an  exchange  of  cash  for  merchandise  re- 
sults in  an  increase  in  one  form  of  property  and  in  an  equal  de- 
crease in  another  form.  Merchandise  is  debited  and  cash  is 
credited,  and  the  total  asset  balances  remain,  not  only  un- 
changed, but  equal  to  the  total  liability  and  proprietorship  bal- 
ances. If  a  business  buys  merchandise  on  time,  merchandise  is 
debited  and  the  account  of  the  creditor  is  credited.  In  other 
words,  the  merchandise  balance  is  increased,  and  the  total  of 
creditor  accounts  is  increased  by  the  same  amount.  The  asset 
balances  and  the  liability  balances  have,  therefore,  been  in- 
creased by  an  equal  amount,  without  in  any  wise  disturbing 
the  equality  of  total  debits  and  total  credits.  If  a  business 
pays  cash  to  a  creditor,  the  balance  of  cash  and  the  balance 
of  the  creditor  account  are  both  decreased  by  the  same  amount. 
The  net  result  is  an  equal  decrease  in  the  total  asset  balances 
and  in  the  total  of  liability  and  proprietary  balances,  the  equal- 
ity of  the  totals  being  unaffected.  If  a  business  settles  an  ac- 
count with  a  note,  one  liability  account  is  decreased  and  an- 
other liability  account  is  increased  by  a  corresponding  amount. 
In  other  words,  the  total  of  accounts  payable  and  notes  pay- 
able remains  unchanged,  and  the  equality  of  asset  balances 
and  liability  balances  is  still  maintained. 

These  illustrations  are  examples  of  the  possible  combinations 
growing  out  of  the  various  types  of  transactions.  These  com- 
binations may  be  diagrammatically  represented  as  follows: 

(i)     Increase  in  an  asset  balance  —  Increase  in  a  liability  or  pro- 
prietorship balance. 
(Debit)  (Credit) 

(2)  Increase  in  an  asset  balance  —  Decrease  in  an  asset  balance. 

(Debit)  (Credit) 

(3)  Decrease  in  a  liability  or  pro Decrease  in  an  asset  balance 

prietorship  balance. 

(Debit)  (Credit) 

(4)  Decrease  in  a  liability  or  pro-  —  Increase  in  a  liability  or  pro- 

prietorship balance.  prietorship  balance. 

(Debit)  (Credit) 


36  ACCOUNTING  PRINCIPLES 

These  combinations  follow  as  a  matter  of  course  from  the 
original  assumption  that  assets  shall  be  debit  balances  and 
that  liabiUties  and  proprietorship  items  shall  be  credit  bal- 
ances. In  other  words,  there  can  be  no  greater  total  of  things 
owned  than  that  of  ownership  claims  against  them,  and  no 
transaction  can  arise  to  change  the  balances  of  things  owned 
without  at  the  same  time  producing  an  equal  opposite  change 
in  the  balances  of  things  owed. 

15.  The  Trial  Balance  —  In  order  to  test  the  equaUty  of 
assets  and  liabilities,  a  trial  balance  of  all  accounts  is  periodi- 
cally made.  In  taking  a  trial  balance,  the  accounts  are  first 
listed  in  the  same  order  in  which  they  stand  in  the  account 
record.  The  debit  balances  are  then  set  down  opposite  the  ap- 
propriate accounts  in  one  column,  while  the  credit  balances  are 
set  down  in  the  same  way  in  a  second  column  to  the  right  of 
the  previous  one.  Since  the  total  debit  balances  should  always 
equal  the  total  credit  balances,  the  total  of  the  first  column 
should  equal  the  total  of  the  second  column.  A  difference  in 
the  footings  indicates  that  an  error  has  been  made. 

The  trial  balance  is  commonly  taken  before  the  revenue  ac- 
counts are  closed  into  profit  and  loss.  If  taken  again  after  the 
revenue  accounts  have  been  closed  into  profit  and  loss,  and 
profit  and  loss  has  been  closed  into  the  capital  account,  the 
two  columns  of  the  trial  balance  represent  the  assets  on  the 
one  side  and  the  liabilities  and  proprietorship  on  the  other.  In- 
stead of  a  second  or  post  closing  trial  balance,  a  revenue  state- 
ment and  balance  sheet  are  usually  made  a.fter  the  closing  of 
the  revenue  accounts  into  profit  and  loss  and  profit  and  loss 
into  the  capital  account.     (See  p.  41.) 

A  trial  balarxe  can  be  made  by  using  for  the  debit  column 
the  total  of  the  debits  for  each  account  listed  and  for  the  credit 
column  the  total  of  the  credits  for  each  of  these  accounts. 
The  trial  balance  consisting  of  the  balances  of  the  several 
accounts,  as  shown  on  p.  41,  is  the  type  most  commonly  used 
because  it  furnishes  the  data  needed  in  the  construction  of  the 
balance  sheet  and  revenue  statement. 


ACCOUNTS,   THEIR  RELATION  TO   STATEMENT         37 

Transactions  for  Illustration  No.  5 
1920 
July    I     Simon  Young  invests  $1500.00  in  a  general  merchandise 

business,  and  also  turns  over  land    worth    $1100.00 

and  buildings  worth  $1200.00. 

2  Buys  for  cash  merchandise  amounting  to  $800.00. 

3  Buys  on  time  from  Andrew  Johnson  &  Co.  merchandise  to 

the  amount  of  $500.00. 

4  Sells  merchandise  to  Ben  Rastall  on  time  for  $500.00. 

5  Borrows  $500.00  on  his  note. 

6  Buys  for  cash  merchandise  amounting  to  $600.00. 

8  Sells  for  cash  merchandise  to  the  amount  of  $125.00. 

9  Sells  to  John  Commons  on  time  merchandise  amounting  to 

$700.00. 

10  Sells  to  Ben  Rastall  on  account  merchandise  amounting  to 

$300.00. 

11  Ben  Rastall  gives  his  note  for  $300.00  in  settlement  of  his 

purchase  of  July  10. 

12  Receives  $400.00  from  John  Commons  on  account. 

13  Purchases  from  Andrew  Johnson  &  Co.  on  account  mer- 

chandise amounting  to  $700.00. 

15  Receives  $300.00  for  cash  sales. 

16  Pays  $500.00  to  Andrew  Johnson  &  Co.  on  account. 

17  Pays  $100.00  for  rent  of  store. 

18  Withdraws  for  personal  use  $150.00  cash. 

19  Sells  merchandise  to  John  Commons  on  time  amounting  to 

$400.00. 

20  Pays  $250.00  for  expenses  of  oflSce. 

22  Buys  merchandise  from  Andrew  Johnson  &  Co.  on  account 

to  the  amount  of  $900.00. 

23  Sells  merchandise  for  cash  to  the  amount  of  $500.00. 

24  Pays  $100.00  for  wages  and  salaries. 

25  Receives  note  of  $300.00  from  John  Commons  on  account. 

26  Receives  $300.00  from  Ben  Rastall  in  settlement  of  his  note. 

ILLUSTRATION  NO.  5 

Set  of  Accounts 

After  taking  a  trial  balance,  the  revenue  accounts  are  closed  into 
profit  and  loss,  which  in  turn  is  closed  into  capital.  As  these  closings 
are  usually  made  through  journal  entries,  to  be  described  in  the  fol- 
lowing chapter,  the  closing  entries  in  the  revenue  and  profit  and  loss 
accounts  are  made  in  black.  The  same  is  true  of  the  gain  on  mer- 
chandise entry  in  the  merchandise  account.     If,  however,  the  closing 


38 


ACCOUNTING  PRINCIPLES 


balances  were  entered  without  being  first  placed  in  the  journal,  they 
would  be  written  in  red  even  in  the  case  of  the  revenue  and  the  profit 
and  loss  accounts. 

Cash 


I9I8 
July 

I 

1500 

oo 

I9I8 

July 

2 

800 

00 

5 

500 

DO 

e 

60c 

oo 

8 

125 

00 

16 

50c 

00 

12 

400 

00 

17 

100 

00 

15 

300 

00 

18 

ISO 

00 

23 

500 

00 

20 

250 

00 

26 

112$ 

300 

00 

24 

100 

00 

Balance 

3625 

00 
CX) 

26 

Balance 

= 

2500 
I125 

00 
00 

362.'; 

3625 

00 

July 

27 

"25 

00 

Notes  Receivable 


I9I8 
July 

II 

300 

CX5 

I918 

July 

26 

300 

oo 

25 

300.00 

300. 

00 

Balance 

300 

00 

600 

00 

600 

00 

July 

27 

Balance 

300 

00 

Ben  Rastall 

1918 
July 

4 

500 

CX) 

1918 

July 

II 

300 

00 

10 

500.00 
Balance 

300 

00 

26 

Balance 

500 

00 

800 

00 

800 

00 

July 

27 

Soo 

00 

ACCOUNTS,  THEIR  RELATION  TO   STATEMENT         39 
John  Commons 


I9I8 

July 

5 

19 

July 

27 

700 

00 

1918 
July 

12 

400.00 

400 

00 
00 

25 
26 

IIOO 

alance 

400 

00 

Balance 


400 
300 
400 


IIOO 


Merchandise 


I9I8 
July 

2 

800 

00 

1918 

July 

4 

500 

00 

3 

500 

00 

£ 

125 

00 

6 

600 

00 

9 

700 

00 

13 

700 

00 

10 

300 

00 

22 

900 

00 

15 

300 

00 

26 

Gross 
Profits 

Mdse.Inv. 

3S00 
650 

00 
00 

19 
23 
26 

650.00 
Inventory 

400 

500 

282s 

1325 

00 

00 
00 

DO 

4150 

00 
00 

4150 

00 

July 

27 

1325 

Notes  Payable 


1918 
July 


25 


Balance 


Soo 

00 

1918 
July 

5 
27 

July 

7    Balance 


500 


SCO 


40 


ACCOUNTING  PRINCIPLES 
Andrew  Johnson  &  Co. 


1918 
July 


16 

500 

00 

I918 

July 

3 

26 

Balance 

1600 

00 

13 

22 

2100 

CX3 

July 

27 

1600.00 


Balance 


500  ( 
7001 
900  < 

2700  ( 
2IOOI 
1600  ( 


Rent 


1918 
July 


1918 
July 


26 


Profit  and 
Loss 


Miscellaneous  Expense 


1918 
July 


20 

250 

00 

I9I8 

26 

Profit  and 
Loss 


250  ( 


Wages  and  Salaries 


1918 
July 


24 

IOC 

00 

I9I8 

July 

26 

1 

Profit  and 
Loss 


Simon  Young,  Personal 


1918 
July 


18 


1501 


1018 
July 


26 


Capital 


150  ( 


ACCOUNTS,   THEIR   RELATION  TO  STATEMENT         4 1 
Profit  and  Loss 


I9I8 
July 

26 

Rent 

Expense 

Wages  & 
Salaries 

Net 
Profits 

100 

250 

100 

200 

00 
00 

00 

00 

1918 
July 

26 

Gross 
Profit 

650 

00 

650 

650 

00 

00 

Simon  Young,  Capital 


1918 
July 


Personal 
Balance 


ISO 
1550 

00 
00 

1918 
July 

I 
26 

27 

1700 

00 

July 

1550.00 
Net  Profits 


Bal.Capital 


Simon  Young 
Trial  Balance,  July  26,  1920 


1500 
200 


1700 


1550 


Cash 

Notes  Receivable 
Ben  Rastall    .      .      . 
John  Commons    . 
Merchandise  . 
Notes  Payable 
Andrew  Johnson  &  Co. 

Rent 

Miscellaneous  Expense 
Wages  and  Salaries  . 
Simon  Young,  Personal 
Simon  Young,  Capital 


II25 

300 

500 

400 

3500 


100 
250 
100 
150 

6425 


500 
1600 


1500 
6425 


42 


ACCOUNTING  PRINCIPLES 


Simon  Young 
Balance  Shed,  July  26,  1920 


Assets 

Current  Assets 
Cash  $1125 

Notes  Rec.  3cxd 
John  Commons  400 
Ben  Rastall  500 
Mdse.  Inv.       1325 

Fixed  Assets 
Buildings  1 200 

Land  1000 


Liabilities  and  Pro- 
prietorship 
Current  Liabilities 

Notes  Payable       $500 

.\ndrew  Johnson 
&  Co.  1600 

Fixed  Liabilities 

Mtg.  Payable 
Proprietorship 

Simon  Young,  Cap. 


2750 


85850 


PROBLEMS  AND   QUESTIONS 

1.  Check  the  entries  in  Illustration  No.  5  and  note  the  account  debited 
and  the  account  credited  for  each  transaction. 

2.  On  a  sheet  of  ledger  paper,  oj)en  the  following  accoimts:  Henrj' 
Lovell  (proprietor);  personal;  cash;  merchandise.  Balance  the  cash  ac- 
count, and  then  take  a  trial  balance  of  the  three  accounts. 

Jime  I    Henry  Lovell  b^ins  a  cash  grocery  business,  investing  $1000.00 
in  cash. 

2  He  buys  groceries  for  $500.00  cash. 

3  He  sells  groceries  for  $25.00  cash. 

4  His  cash  sales  for  the  day  amount  to  $22.00. 

5  He  returns  groceries  bought  on  June  2,  receiving  a  refund  of 

$10.00  cash. 

6  His  cash  sales  for  two  daj-s  amount  to  $47.00. 

7  A  customer  returns  groceries  which  proved  unsatisfactor>-,  and 

receives  a  refimd  of  $1.25  cash. 

8  He  takes  for  his  own  use  groceries  amounting  to  $12.50. 

9  Cash  sales  for  three  daj-s  amount  to  $62.40. 

10  He  buj's  groceries  for  $250.00  cash. 

11  Cash  sales  for  two  days  amount  to  $46.25. 

3.  What  are  the  two  fundamental  assumptions  of  double-entr>-  book- 
keeping? 

4.  WTiat  is  the  purpose  of  an  accoimt? 

5.  Give  the  rule  for  debiting  and  crediting  asset  accounts. 

6.  Give  the  rule  for  debiting  and  crediting  liability  accounts. 

7.  \Miy  does  the  rule  for  debiting  and  crediting  liability  accounts  ser\-e 
also  as  the  rule  for  debiting  and  crediting  profit  and  loss  and  the  revenue 
accoimts? 

8.  In  analx-zing  a  transaction  to  determine  what  account  should  be  deb- 
ited and  what  amount  should  be  credited,  what  questions  should  be  asked 
and  answered  before  making  the  entries? 

9.  Why  is  the  merchandise  account  called  a  mixed  account? 


CHAPTER   IV 

THE  JOURNAL  AND   LEDGER 

I.  Ledgers.  —  The  form  of  accounts  has  already  been  indi- 
cated by  examples  in  the  preceding  chapter.  The  rulings 
shown  in  these  accounts  are  those  ordinarily  used  in  the  stand- 
ard ledger,  each  page  of  which  has  space  for  the  following: 

Debit  Side  Credit  Side 

Date  Explanation  Folio  Amount    Date  Explanation  Folio  Amount 

(See  rulings  for  ledger  accounts  at  the  end  of  Chapter  III.) 

For  accounts  requiring  daily  or  frequent  balancing,  a  balance' 
ledger  is  provided,  with  separate  balance  columns,  ruled  as  fol- 
lows : 
Date  Balance  Folio  Debits  Credits  Debit  Balance  Credit  Balance 

Banks  and  public  service  companies  frequently  use  still  an- 
other form  of  ledger,  known  as  the  Progressive  or  Boston 
Ledger,  for  keeping  their  customers'  accounts.  In  this  type, 
each  line  carries  a  separate  account,  and,  through  a  shortening 
of  the  sheets  following  the  one  on  which  the  names  are  written, 
ordinarily  extends  over  several  pages.  The  ruling  of  such  a 
ledger  is  as  follows: 

Month  •         Month 

Name   Balance  Debit   Credit   Balance  Debit   Credit  Balance   Etc. 

If  the  balances  are  monthly  balances,  the  names  of  the 
months  appear  above  the  successive  Debit  -  Credit  -  Balance 
groups.  If  the  balances  are  daily  balances,  the  days  of  the 
week  are  used  instead.  Whether  monthly  or  daily,  however, 
only  one  column  for  the  balances  is  provided. 

In  the  case  of  a  bank,  the  depositor's  balance  is  ordinarily  a 
credit  balance.    Consequently,  if  the  account  is  overdrawn,  the 

43 


44  ACCOUNTING  PRINCIPLES 

debit  balance  is  entered  in  red  to  distinguish  it  from  the  pre- 
vailing credit  balances.  In  the  case  of  a  public  service  com- 
pany, on  the  other  hand,  the  customer's  balance  is  usually  a 
debit  balance,  and  a  credit  balance,  arising  from  an  overpay- 
ment of  the  account,  is  entered  in  red  to  distinguish  it  from  the 
debit  balances  commonly  foimd. 

The  ledger  itself  may  be  either  a  bound  book,  a  loose-leaf 
book,  or  a  card  index  ledger.  The  loose-leaf  form  is  very  com- 
monly employed,  on  account  of  the  possibility  of  removing  the 
sheets  that  contain  inactive  accounts.  The  card  ledger  is  even 
more  readily  adjustable  than  the  loose-leaf  ledger.  In  fact,  the 
readiness  with  which  an  account  can  be  removed  from  the  card 
ledger  frequently  results  in  the  loss  or  misplacement  of  ac- 
counts. 

2.  The  JoumaL  —  The  transactions  recorded  in  the  ledger 
are  all  grouped  under  the  particular  accounts  to  which  they 
refer.  Moreover,  no  explanations  are  placed  in  a  ledger  ac- 
count, except  such  as  may  be  necessary  in  connection  with  rou- 
tine transactions  with  the  individual  or  firm  concerned.  There 
is  needed,  therefore,  a  chronological  record  of  all  transactions, 
with  a  full  explanation  of  each. 

The  old  Day  Book  contained  such  a  diary  and  explanation. 
In  connection  with  it,  however,  a  second  book  was  necessary 
to  indicate  the  accounts  debited  and  credited  for  the  various 
transactions  described.  Two  books  of  original  entr>'  were  thus 
required.  Later,  the  functions  of  these  two  books  were  com- 
bined in  the  Journal,  which  was  devised  to  contain  both  the 
diar}'  and  explanator>'  data  and  the  entries  showing  the  ac- 
counts debited  and  credited.  This  process  of  entering  the  items 
of  a  transaction  in  the  Journal  is  spoken  of  as  journalizing. 
From  the  Journal,  the  debits  and  credits  are  carried,  respec- 
tively, to  the  debit  and  credit  sides  of  the  appropriate  ledger  ac- 
counts.   This  transfer  is  conunonly  called  posting. 

The  rulings  of  the  journal  usually  provide  for  the  following 
headings: 

Folio    Account    Debit    Credit 

(See  rulings  for  journal  entries  in  Illustration  No.  6  at  end  of  this  Ch^ter.) 


THE  JOURNAL  AND  LEDGER  45 

Sometimes,  in  addition  to  the  columns  just  indicated,  there  is 
a  small  column  to  the  left  of  the  debit  column,  to  be  used  for 
the  folio  reference.  Where  such  additional  column  is  provided, 
the  first  column,  instead  of  being  used  for  the  folio,  is  fre- 
quently used  as  a  date  column.  In  the  exercise  material  of  the 
text,  the  date  is  inserted  on  a  blank  line  above  the  debit  and 
credit  entries  to  which  it  pertains. 

The  form  of  the  journal  entries  and  the  method  of  entering 
the  explanatory  data  are  indicated  below  in  Illustration  No.  6, 
which  shows  the  journalizing  of  the  transactions  contained  in 
Illustration  No.  5. 

3.  Checking  the  Posting.  —  At  definite  intervals,  such  as 
once  a  week  or  once  a  month,  the  postings  from  the  journal  to 
the  ledger  are  checked,  the  work  being  done  according  to  the 
following  plan:  (i)  The  diary  of  transactions  is  compared  with 
the  journal  entries  for  each  item.  If  the  diary  and  the  entries 
agree,  they  are  both  checked,  to  indicate  that  the  transaction 
has  been  properly  journalized.  (2)  The  journal  entries  for  each 
transaction  are  then  compared  with  the  corresponding  ledger 
posting.  If  the  entries  and  the  postings  agree,  the  ledger  item 
is  also  checked  to  indicate  that  the  journal  entries  have  been 
properly  posted.  (3)  The  additions  of  the  debits  and  credits 
of  the  various  ledger  accounts,  as  well  as  the  calculations  of  the 
various  balances,  are  then  verified,  and  the  balances  entered  on 
the  trial  balance  sheet.  (4)  If  the  sum  of  the  debit  balances  of 
the  trial  balance  does  not  equal  the  sum  of  the  credit  balances, 
the  debit  entries  and  the  credit  entries  are  totaled  on  each  page 
of  the  journal  and  carried  forward  to  the  succeeding  page  until 
the  complete  total  of  all  journal  debits  and  the  complete  total 
of  all  journal  credits  have  been  found.  If  these  totals  agree, 
the  difference  in  the  trial  balance  footings  is  clearly  due  to  an 
error  in  the  ledger  postings.  (5)  The  difference  between  the 
sum  of  the  debit  balances  and  the  sum  of  the  credit  balances  of 
the  trial  balance  is  then  taken.  If  this  difference  is  divisible  by 
2,  the  indication  is  that  a  debit  has  been  posted  as  a  credit,  or 
vice  versa.  If  the  difference  is  divisible  by  9,  the  possibility  is 
that  there  has  been  a  transposition  (such  as  entering  36  as  63) 


46  ACCOUNTING  PRESTCIPLES 

or  a  slide  (such  as  entering  S125.00  as  S12.50)  in  connection 
with  entering  some  particular  item,  the  difference  in  such  cases, 
owing  to  the  nature  of  the  decimal  system,  always  being  divis- 
ible by  9.  If  the  sum  of  the  debit  balances  differs  from  the  stun 
of  the  credit  balances  by  i,  or  10,  or  some  power  of  10,  the 
likelihood  is  that  an  error  has  been  made  in  addition.  This  is 
not  necessarily,  though  very  commonly,  the  case.  Thus,  these 
tests  in  connection  with  the  difference  between  the  total  debits 
and  the  total  credits  of  the  trial  balance  afford  an  indication  of 
the  character  of  the  error  likely  to  be  discovered  in  a  recheck 
of  the  accounts,  and  frequently  effect  a  shortening  of  the  work. 

Although  a  difference  between  the  total  debits  and  the  total 
credits  of  a  trial  balance  definitely  indicates  that  an  error  in 
posting  or  journalizing  has  been  made,  an  agreement  between 
the  two  totals  does  not  conclusively  prove  that  the  work  has 
been  accurately  done.  For  instance,  some  item  in  the  diar\'  of 
transactions  resulting  in  an  equal  debit  and  credit  may  have 
been  omitted  entirely  from  the  journal,  and  consequently  also 
from  the  ledger.  Neither  omission  would  prevent  an  equaUty 
of  debit  and  credit  balances,  although  the  work  as  a  whole 
would  be  incorrect.  In  other  words,  an  equahty  of  totals  in 
the  trial  balance  merely  indicates  a  probability  that  the  work 
has  been  correctly  done.  Only  a  complete  recheck,  such  as 
outlined  above,  can  be  regarded  as  positive  proof. 

4.  Closing  Accounts  through  the  Journal.  —  In  closing  the 
accounts  which  go  into  the  balance  sheet,  the  word  balance  is 
entered  in  red  along  with  the  amount  of  the  balance.  All  ac- 
coimts  not  closed  into  the  balance  sheet  are  generally  closed 
through  the  journal,  the  closing  entries  in  such  cases  being  in 
black. 

In  dosing  through  the  journal,  the  closing  entry  of  the  ac- 
count is  journalized  before  being  entered  in  the  ledger.  For 
example,  if  the  debit  balance  of  the  wages  account  is  $500.00, 
the  account  is  closed  into  profit  and  loss  through  the  following 
journal  entries: 

Profit  and  Loss — ^Wages  500.00 

Wages — Profit  and  Loss  500  00 


THE  JOURNAL  AND  LEDGER  47 

These  journal  entries  indicate  that  the  debit  balance  of  the  ac- 
count is  to  be  carried  to  the  debit  side  of  the  profit  and  loss 
account,  and  that  at  the  same  time  the  wages  account  is  to  be 
closed  by  the  proper  ledger  entry.  Other  accounts  closed  into 
profit  and  loss  would  be  similarly  journalized  before  being 
finally  closed. 

The  balance  of  the  profit  and  loss  account  is  also  journalized 
before  being  closed  into  the  capital  account.  For  instance,  if 
the  credit  balance  of  profit  and  loss  is  $250.00,  the  proper  jour- 
nal entries  are  as  follows: 

Profit  and  Loss — Net  Profits       250.00 

Capital — Net  Profits  250.00 

In  closing  accounts  into  profit  and  loss  and  into  capital,  it  is 
customary  to  enter  along  with  the  debit  and  credit  balances 
the  names  of  the  accounts  from  which  they  come.  The 
necessary  information  is  entered,  therefore,  in  the  journal, 
the  journal  entries  indicating  not  only  the  accounts  to  which 
the  items  are  to  be  posted,  but  also  the  accounts  from 
which  the  items  are  transferred.  As  each  item  is  posted  from 
the  journal  to  the  ledger,  there  is  inserted  in  the  journal  folio 
the  page  of  the  ledger  to  which  the  item  is  carried,  and  in 
the  ledger  folio  the  page  of  the  journal  from  which  the 
transfer  is  made. 

5.  Journal  Closing  of  the  Merchandise  Account.  —  Since  the 
merchandise  inventory  is  not  an  item  arising  out  of  the  regular 
transactions  of  a  business,  it  is  frequently  entered  in  red  to 
the  credit  of  the  merchandise  account  in  connection  with  the 
calculation  of  the  gain  on  merchandise.  This  gain  is  entered 
through  the  journal,  the  inventory  being  brought  down  as  the 
debit  balance  of  the  merchandise  account  for  the  succeeding 
period.  If  the  gain  on  merchandise  for  the  period  under  con- 
sideration is,  say,  $300.00,  the  amount  is  closed  into  profit  and 
loss  through  the  following  journal  entries: 

Merchandise — Gross  Profits        300 .  00 

Profit  and  Loss — Gross  Profits  300.00 


48  ACCOUNTING  PRINCIPLES 

The  merchandise  inventory  is  sometimes  also  entered  through 
the  journal.  When  this  is  done,  however,  it  is  necessary  to 
open  a  merchandise  inventory  account  simply  for  the  purpose 
of  accommodating  the  journal  entry.  The  loss  in  time  does 
not  result  in  any  gain  in  clearness,  and  is  at  variance  with  the 
conunon  practice  of  entering  asset  balances  in  red  when  asset 
accoimts  are  closed.  The  method  indicated,  therefore,  in  the 
preceding  paragraph  will  be  followed  in  the  exercise  material  of 
the  text,  unless  the  student  is  otherwise  directed. 

6.  Opening  Journal  Entries.  —  In  the  illustrations  thus  far 
given,  the  opening  journal  entry  has  been  an  investment  of 
cash,  and  the  item  has  been  journalized  like  any  other  cash 
transaction.  Frequently,  however,  the  owner  invests  not  merely 
cash  but  also  other  forms  of  property.  The  form  of  asset  con- 
tributed is  immaterial  so  far  as  concerns  the  credit  of  the  owner 
on  the  books  of  the  business.  For  instance,  instead  of  invest- 
ing $10,000.00  in  cash,  John  Smith  might  invest  in  business 
$5000.00  in  cash,  $3000.00  in  land,  and  $2000.00  in  buildings. 
The  journal  entries  would  then  be: 


Cash 

5.000.00 

T^nd 

3,000.00 

Buildings 

2,000.00 

John  Smith,  Capital 

10,000.00 

Investment  of  John  Smith 

If  against  the  land  and  buildings  there  should  be  outstanding 
a  mortgage  payable  of  $2,500.00,  the  investment  of  John  Smith 
would  be  the  difference  between  the  total  assets  and  the  mort- 
gage liability.  The  journal  entries  in  this  case  would  there- 
fcM-e  be: 


Cash 

5.000.00 

T^nd 

3,000.00 

Buildings 

2,000.00 

Mortgage  Payable 

2,500.00 

John  Smith,  Capital 

7,500.00 

Investment  of  the  assets  of  John  Smith,  the 
outstanding  mortgage  being  assumed 
by  the  business 


THE  JOURNAL  AND  LEDGER 


49 


Accounting  texts  generally  prefer  the  following  form  of  entry: 


Cash                                           5,000.00 

Land                                           3,000.00 

Buildings                                    2 ,000 .  00 

John  Smith,  Capital 

10,000.00 

Investment  of  the  assets  of  John  Smith 

John  Smith,  Capital                  2,500.00 

Mortgage  Payable  2 ,  500 .  00 

Assumption  of  mortgage  against  John  Smith's  assets 

The  net  result  is  the  same  as  in  the  preceding  form. 

In  support  of  the  use  of  the  latter  form,  it  is  argued  that  this 
form  of  entry  gives  a  fuller  analysis  of  the  steps  taken  and  is 
more  easily  understood  by  the  student  or  the  user  of  the  ac- 
counting record.  If  the  student  is  taught,  however,  that  an 
asset  represents  something  which  a  business  owns,  and  that  the 
corresponding  credit  entry  always  represents  the  source  of  the 
asset  received,  he  will  more  readily  grasp  the  condensed  form 
of  entry  first  presented  above.  Experience  in  teaching  both 
forms  of  entry  has  convinced  the  author  that  much  time  is 
saved  and  nothing  is  lost  by  the  use  of  the  shorter  form. 

ILLUSTRATION  NO.  6 
Journal  Entries,  July,  1918 


Cash 

Simon  Young,  Capital 
Investment  in  general  merchandise 
business 


Merchandise 

Cash 
Purchase  of  merchandise  for  cash 


Merchandise 

Andrew  Johnson  &  Co. 
Purchase  of  merchandise  on  time 


1500 

00 

1500 

00 

800 

GO 

800 

00 

Soo 

GO 

500 

00 

50 


ACCOUNTING  PRINCIPLES 


29 
27 

4 
Ben  Rastall 

Merchandise 
Sale  of  merchandise  on  time 

500 

CX3 

500 

00 

26 

27 

S 
Cash 

Notes  Payable 
Loan  on  note 

500 

00 

500 

00 

27 
26 

,  6 

Merchandise 

Cash 
Purchase  of  merchandise  for  cash 

600 

00 

600 

00 

26 

27 

8 
Cash 

Merchandise 
Sale  of  merchandise  for  cash 

9 

125 

00 

125 

00 

29 
27 

John  Commons 
Merchandise 
Sale  of  merchandise  on  time 

700 

00 

700 

CO 

29 
27 

ID 

Ben  Rastall 

Merchandise 
Sale  of  merchandise  on  time 

II 

300 

00 

300 

00 

1 

27 
29 

Notes  Receivable 

Ben  Rastall 

Settlement  of  bill  of  July  10 

300 

00 

300 

00 

27 
29 

12 
Cash 

John  Commons 
Payment  on  account 

40c 

" 

400 

00 

27 
28 

13 
Merchandise 

Andrew  Johnson  &  Co. 
Purchase  of  merchandise  on  time 

700 

00 

700 

00 

THE  JOURNAL  AND  LEDGER 


51 


26 

27 

IS 
Cash 

Merchandise 
Sales  for  cash 

16 

300 

00 

300 

00 

28 

26 

Andrew  Johnson  &  Co. 

Cash 
Payment  on  account 

500 

00 

500 

00 

28 
26 

17 
Rent 

Cash 
Payment  of  rent 

18 

100 

00 

100 

00 

26 
26 

Simon  Young,  Personal 

Cash 
Withdrawal  of  cash  for  personal  use 

150 

00 

150 

00 

29 

27 

19 
John  Commons 
Merchandise 
Sale  of  merchandise  on  time 

400 

00 

400 

00 

28 
26 

20 
Expense 
Cash 
Payment  of  office  expense 

250 

cx> 

250 

00 

27 
28 

22 
Merchandise 

Andrew  Johnson  &  Co. 
Purchase  of  merchandise  on  time 

900 

00 

900 

00 

26 
27 

23 
Cash 

Merchandise 
Sale  of  merchandise  for  cash 

24 

500 

00 

SCO 

00 

28 
26 

Wages  and  Salaries 

Cash 
Payment  of  wages 

100 

00 

100 

CO 

52 


ACCOUNTING  PRINaPLES 


26 

27 


27 
29 


29 
28 


29 
28 


29 
28 


29 


26 
26 


25 

Notes  Receivable 
John  Commons 
Payment  of  note  on  account 

36 

Cash 

Notes  Receivable 
Payment  of  Ben  Rastall  note 


Closing  Entries 

Merchandise — Gross  Profits 

Profit  and  Loss — Gross  Profits 
Close  of  merchandise  account  into 
profit  and  loss 

Profit  and  Loss — Rent 

Rent — Profit  and  Loss 
Close  of  rent  account  into  profit  and 
loss 

Profit  and  Loss — Office  Expense 

Expense — Profit  and  Loss 
Close  of  expense  account  into  profit 
and  loss 

Profit  and  Loss — ^Wages  and  Salaries  . 
Wages  and  Salaries — Profit  and 

Loss 
Close  of  wages  and  salaries  account 

into  {Hofit  and  loss 

Profit  and  Loss — Net  Profits 
Simon     Yoimg,     Capital  —  Net 

Profits 
Close  of  profit  and  loss  account  into 

capital 

Simon  Young,  Capital — Personal 

Simon  Yoimg,  Personal 
Close  of  personal  account  into  capital 


30000 


30000 


300  < 


30000 


650  ( 


650  < 


250 


25000 


150  ( 


15000 


THE  JOURNAL  AND  LEDGER  53 

Instead  of  making  a  separate  set  of  journal  entries  for  each 
account  closed  into  profit  and  loss,  a  compound  entry  is  some- 
times made  to  cover  related  items,  as  follows: 

Closing  Entries 


Profit  and  Loss                            450 .  00 

Rent 

100.00 

Expense 

250.00 

Wages  and  Salaries 

100.00 

Close  of  expense  accounts  into 

profit  and  loss 

The  additional  closing  entries  affecting  the  profit  and  loss 
and  trading  accoimts  would  be  the  same  as  those  given  above  in 
connection  with  the  more  detailed  journalization  of  the  closing. 

PROBLEMS  AND   QUESTIONS 

I.  With  the  use  of  journal  and  ledger  paper,  journalize  and  post  the 
following  transactions.  Take  a  trial  balance  of  the  accounts,  and  close  the 
merchandise  and  profit  and  loss  accounts  through  the  journal. 

The  accounts  to  be  used  are  Ernest  Nason,  Capital;  Ernest  Nason, 
Personal;  Cash;  Merchandise;  Real  Estate;  Store  Fixtures;  Expense;  Notes 
Receivable;  Notes  Payable;  Discount  on  Purchases;  and  such  personal  ac- 
counts as  may  be  necessary. 

1918 

Jan.    I     Ernest  Nason  invests  $4000.00  in  cash  and  $2200.00  in  merchan- 
dise in  business. 

2  Buys  store  building  and  lot  for  $3400.00  cash. 

3  Buys  fixtures  for  store  for  $450.00  cash. 

4  Buys  2/10,  n/30,  from  Leonard  Nelson  &  Co.  on  accoimt  merchan- 

dise to  the  amount  of  $1000.00.     Pays  freight  in  cash,  $40.00. 

5  Sells  to  OUver  Goldthorpe  on  account  merchandise  amoimting  to 

$120.00. 

6  Cash  sales,  $385.00. 

7  Sells  to  Oliver  Goldthorpe  on  account  merchandise  amounting  to 

$295.00,  and  to  Lynn  Knorr  on  account  goods  to  the  value  of 
$434.00. 

8  Takes  Lynn  Knorr's  note  at  30  days  in  payment  of  accovmt. 

9  Buys  from  Quincy  Quigley  &  Co.  on  account  merchandise  amount- 

ing to  $894.00. 
10     Pays  out  $65.00  cash  for  sundry  expenses. 
,■  n     Pays  freight  in  cash  $52.00. 

12     Cash  sales,  $231.00. 


54  ACCOUNTING  PRINCIPLES 

Jan.  13  Pays  the  account  of  Leonard  Nelson  &  Co.,  due  tomorrow,  less 
the  discount. 
Nelson  &  Co.  are  debited  for  the  full  amount  of  the  account, 
since  the  account  is  fully  settled;  cash  k  credited  for  the 
amount  of  cash  actually  remitted;  and  discount  on  purchases 
is  credited  for  the  amount  of  the  discount  earned. 

14  Sells  L>Tin  Knorr  on  account  goods  amounting  to  $276.00. 

15  Borrow-s  from  the  City  Bank  $1000.00,  gi\-ing  his  note  for  that 

amount. 

16  Pa>-s  simdrv'  expenses  in  cash  $23.00. 

17  Cash  sales,  $314.00. 

18  Withdrawn  $50.00  in  cash  for  personal  expenses. 

19  Bu}-s  merchandise  on  account  from  Leonard  Nelson  &  Co.  amount- 

ing to  $725.00,  2/10,  n/30. 
^lerchandise  inventorj-,  January-  20,  1918,  $3624.00. 

2.  From  the  trial  balance  of  Problem  i  make  the  journal  entries  necessary- 
to  close  the  revenue  accounts  into  profit  and  loss  and  profit  and  loss  into 
capital. 

3.  Explain  the  ruling  and  use  of  a  balance  ledger  and  of  the  Boston 
Ledger.  What  are  the  advantages  and  disadvantages  for  a  card  ledger,  a 
loose-leaf  ledger,  and  of  a  bound  ledger? 

4.  Describe  the  process  of  completely  checking  a  set  of  entries. 

5.  How  is  merchandise  on  hand  at  the  end  of  a  period  entered?     WTij? 

6.  What  is  the  general  rule  for  the  use  of  red  ink  in  closing  entries? 

7.  The  following  transactions  do  not  constitute  a  connected  series,  but 
are  intended  to  furnish  drill  in  anal>'sis.  Make  the  opening  entries  in  each 
case: 

(a)  Harry  Snyder  begins  business  by  investing  cash,  $3000.00;  merchan- 
dise, $2500.00;  store  building  and  lot,  $3500.00;  fixtures,  $700.00. 

(b)  William  Woodhead  begins  business  with  the  following  assets  and 
liabilities:  Cash,  $2000.00;  merchandise,  $2500.00;  deliver)-  equipment, 
$500.00;  open  account  against  L.  W.  Soles,  $600.00;  notes  due  him,  $Soo.oc: 
and  note  due  by  him  to  the  Citizens  Bank,  $750.00. 

(c)  At  the  time  Thomas  Morrison  begins  business,  he  has  the  following 
assets  and  liabilities:  Cash,  $4000.00;  real  estate,  $10,000.00,  encumbered 
with  a  mortgage  pa\-able  of  $4000.00;  merchandise  on  hand,  $3500.00; 
accounts  due  from  the  following  trade  debtors  —  Roy  Black,  $250.00;  William 
Hopkins,  $175.00;  Fred  Root,  $206.00;  notes  receivable,  $975.00;  furniture 
and  fixtures,  $425.00;  prepaid  insurance,  $56.00;  debts  due  to  the  following 
trade  creditors:  The  National  WTiolesale  Co.,  $500.00;  J.  B.  Wells  Co., 
$450.00;  taxes  impaid,  $175.00. 

8.  Journalize  the  following,  omitting  explanations,  i.e.,  use  the  skeleton 
method  of  journal  entries: 

(a)  HenrA-  Jones  buj-s  merchandise  from  J.  F.  Newman  &  Co.  to  the 
amount  of  $600.00,  one-half  cash,  the  balance  on  accoimt. 

(b)  Henr>'  Jones  sells  merchandise  to  James  Chochems  for  $320.00,  re- 
ceiving $100.00  in  cash  and  a  note  at  30  da>-s  for  the  balance. 

(c)  Henr>'  Jones  gives  Sam  Heyman  &  Co.  his  note  for  $400.00  to  settle 
his  account. 


THE  JOURNAL  AND  LEDGER  55 

(d)  Henry  Jones  sells  merchandise  to  Fred  Myers  for  $308.00,  receiving 
in  payment  $100.00  cash,  a  note  of  Nathaniel  Green's  for  $150.00,  indorsed 
by  Myers  to  you,  the  balance  being  charged  on  account. 

9.  A  trial  balance  of  the  ledger  of  the  insurance  agency  of  Sidney  Webb 
as  of  December  31st  follows.  On  sheets  of  ledger  paper  open  the  accounts, 
showing  their  condition  as  of  December  31st  at  the  time  of  closing.  Also 
open  an  account  with  profit  and  loss.  Prepare  the  journal  entries  to  close 
the  revenue  accounts  into  profit  and  loss.  Post  the  entries  and  close  the 
accounts.  Make  and  post  the  entries  to  close  profit  and  loss  and  personal 
into  capital. 


Cash 

1,620.00 

Notes  Receivable 

590.00 

Accounts  Receivable' 

1,450.00 

Furniture  and  Fixtures 

1,400.00 

Real  Estate 

5,000.00 

Accounts  Payable' 

525-00 

Mortgage  Payable 

3,000.00 

Sidney  Webb,  Personal 

1,200.00 

Sidney  Webb,  Capital 

6,000.00 

Premiums  Earned 

3,150.00 

Notary  Fees  Earnc^ 

420 . 00 

Interest  Earned 

370.00 

Salaries 

900.00 

Office  Expense 

275.00 

Heat  and  Light 

31500 

Miscellaneous  Expense 

180.00 

Taxes  and  Insurance 

295.00 

Interest  on  Mortgage 

240.00 

• 

13,465.00 

13,465:00 

1  These  amounts  are  the  sums  of  all  accounts  owing  from  debtors  and  owing  to  creditors 
respectively. 


CHAPTER  V 
THE  FORM  AND   USE   OF  COMMERCIAL  PAPERS 

1.  Design  of  Commercial  Papers.  —  In  connection  with  the 
installation  of  a  system  of  accounts  for  a  business,  it  is  always 
necessary  to  design  the  commercial  papers  to  be  used  in  fur- 
nishing the  data  required  for  the  books  of  record  and  for  the 
information  of  the  parties  with  whom  business  is  transacted. 
Before  any  paper  of  this  kind  is  designed,  however,  there  should 
be  a  definite  plan  for  its  use,  as  such  a  plan  will  determine 
both  the  character  of  information  to  be  furnished  and  the  form 
in  which  it  is  to  be  supplied.  There  are,  of  course,  standard 
forms  for  such  widely  used  papers  as  the  check,  the  promissory 
note,  and  the  draft.  The  form  of  other  papers,  such  as  the 
purchase  order,  the  invoice,  and  the  credit  memorandum,  varies 
according  to  the  requirements  of  the  particular  business. 

2.  Sales  Invoice.  —  When  an  order  for  goods  is  received  by 
a  merchant,  the  articles  are  prepared  for  shipment  and  a  bill 
for  them  is  sent  to  the  purchaser.  This  bill  is  commonly 
known  as  a  sales  invoice,  and  should  contain  all  the  informa- 
tion needed  by  the  bookkeeper  in  journalizing  the  transaction 
and  by  the  buyer  in  checking  the  goods  received  with  the  order 
sent.  Since  the  buyer  may  not  receive  the  goods  promptly,  the 
invoice  should  show  the  route  of  shipment,  if  the  goods  are 
sent  by  freight,  or  the  name  of  the  express  company,  if  they 
are  forwarded  by  express.  Frequently,  the  purchaser  requests 
that  his  order  number  be  given  in  the  invoice;  and  the  invoice, 
in  consequence,  should  provide  for  such  a  request.  The  follow- 
ing form  will  meet  the  needs  of  the  ordinary  mercantile  busi- 
ness: 


56 


THE  FORM  AND  USE  OF  COMMERCIAL  PAPERS 


57 


ILLUSTRATION  NO    7 
Purchase  and  Sales  Invoice 


No. 
VALLEY  FURNITURE  COMPANY 
Valley,  111. 


19- 


Sold  to 
Address 


Shipped  Via 


Date  Shipped 


Buyer's  Order  No. 


Classification 


Article 


Quantity 


Rate 


Charges 


Credits 


A  classification  column,  such  as  indicated  above.  Is  needed 
where  separate  sales  accounts  are  kept  for  different  classes  of 
commodities.  The  charges  and  credits  columns,  of  course,  fur- 
nish the  necessary  information  with  regard  to  the  amounts  to 
be  charged  and  credited  to  the  customer. 

For  over-counter  sales,  a  record  or  memorandum  is  designed 
on  the  basis  of  the  information  necessary  for  the  accounting 
records  and  for  rendering  to  the  purchaser  the  regular  sales  in- 
voice. Usually,  the  record  or  memorandum  is  made  in  dupli- 
cate, one  copy  being  given  to  the  purchaser  at  the  time  of  the 
sale,  the  other  being  retained  by  the  seller  as  the  original  rec- 
ord of  the  transaction. 


58  ACCOUNTING  PRINCIPLES 

3.  Purchase  Invoice.  —  The  sales  invoice  of  the  seller  be- 
comes, of  course,  the  purchase  invoice  of  the  buyer.  When  it  is 
received  by  the  purchaser  in  advance  of  the  goods,  care  should 
be  taken  to  file  it  so  that  a  delay  in  the  arrival  of  the  goods 
will  not  be  overlooked.  A  tickler  file,  with  a  guide  for  each 
day  of  the  month,  is  extremely  useful  in  this  connection,  per- 
mitting the  invoice  to  be  filed  either  in  the  tickler  under  the 
date  on  which  the  goods  should  ordinarily  be  received,  or  in 
the  invoice  file  under  the  name  of  the  seller  with  a  cross-refer- 
ence in  the  tickler  under  the  date  on  which  inquiry  regarding 
the  shipment  should  be  made.  The  precise  method  will  de- 
pend, of  course,  upon  the  volume  of  purchases  and  the  delays 
experienced  in  the  arrival  of  goods. 

The  method  of  checking  goods  received  varies  also  with  the 
size  of  the  business.  In  a  small  concern,  the  goods  may  be 
checked  with  the  invoice  itself,  which  is  then  compared  with 
the  original  purchase  order.  In  a  large  business,  a  copy  of  the 
purchase  order  is  sent  to  the  clerk  who  is  to  receive  them. 
When  the  goods  are  received,  they  are  checked  with  this  duph- 
cate  order,  which  is  then  returned  to  the  bookkeeper  to  serve 
as  a  memorandum  of  goods  received  in  checking  the  purchase 
invoice.  Where  only  part  of  an  order  is  received,  the  receiving 
clerk  sends  to  the  bookkeeper  a  list  of  the  items,  together  with 
the  order  number,  retaining  the  duplicate  order  until  the  re- 
mainder of  the  shipment  arrives.  The  department  store  and 
other  concerns  may  pay  the  invoice  before  the  goods  arrive  in 
order  to  take  discounts,  the  wholesaler  agreeing  to  make 
necessary  adjustments  if  goods  are  not  as  ordered.  The  in- 
voice would  be  entered  on  receipt  of  goods  or  at  time  of  pay- 
ment if  this  date  is  before  receipt  of  goods. 

After  being  completely  verified,  the  invoice  is  entered  to  the 
credit  of  the  seller.  If  the  invoice  has  a  discount  date,  it  is  filed 
in  a  tickler  file  under  the  date  when  payment  must  be  made. 
If  approved  invoices  are  all  paid  at  the  same  time  each  month, 
they  should  be  filed  together  for  future  payment.  When  paid, 
the  invoices  should  be  filed  under  the  name  of  the  creditors  in 
an  appropriate  place.    The  canceled  checks  sent  in  payment 


THE  FORM  AND  USE  OF  COMMERCIAL  PAPERS        59 

might  properly  be  attached  to  the  corresponding  invoices  as 
soon  as  these  checks  are  returned  by  the  bank.  In  any  event, 
a  notation  should  be  made  on  each  invoice  of  the  date  on 
which  it  is  paid. 

The  foregoing  observations  on  the  matter  of  invoice  filing  are 
not  intended  as  definite  rules,  but  rather  as  pointers  on  the 
necessity  of  a  definite  program  for  the  handling  of  commercial 
papers  which  are  related  to  accounting  procedure. 

4.  Promissory  Note.  —  A  promissory  note  is  an  uncondi- 
tional promise  in  writing  by  one  person  to  another,  signed  by 
the  maker,  engaging  to  pay.  on  demand  or  at  a  fixed  or  deter- 
minable future  time  a  certain  sum  of  money  to  order  or  to 
bearer.  The  promise  is  usually  made  to  the  order  of  the  payee, 
who  must  indorse  the  note  to  render  it  transferable  or  nego- 
tiable.   The  general  form  of  the  instrument  is  shown  below. 

ILLUSTRATION  NO.  8 

Promissory  Note 

$5cx3.cx) Valley,  III.,  July  i,  1918. 

. Six  months after  date,  for  value  received 

I promise  to  pay  to  the  order  of John  Smith . 

Five  Hundred  and  0/000 ^  Dollars 

at  the  ^Valley  National  Bank,  Valley,  111 ,  with 

interest  at  the  rate  of eight^ per  cent  per  annum  from 

date until  paid. 

And,  if  this  note  is  not  paid  in  full  at  maturity,  and  it  is  placed  in 
the  hands  of  an  attorney  for  collection,  or  suit  is  instituted  to  enforce 
collection,  then  I  agree  to  pay  an  additional  sum  of  ten  per  cent 
of  the  amount  of  principal  and  interest  of  this  note  as  attorney's 
fees,  which  said  ten  per  cent  shall  be  included  in  the  judgment  which 
may  be  rendered  on  this  note. 

A  ddress, Joshua  Jones 

No Due 7/31/18 

If  the  foregoing  note  were  given  by  Joshua  Jones  to  John 
Smith  in  payment  for  merchandise,  the  transaction  would  be 
journalized  as  follows: 


6o  ACCOUNTING  PRINCIPLES 

(a)  On  the  books  of  Joshua  Jones: 

Merchandise  500 .  00 

Notes  Payable  500.00 

Purchase  of  merchandise  with  note  payable 

(b)  On  the  books  of  John  Smith: 

Notes  Receivable  500 .  00 

Merchandise  500 .  00 

Sale  of  merchandise  for  note  receivable 

5.  Interest  on  Notes.  —  A  promissory  note  usually  bears  in- 
terest, but  the  interest  forms  no  part  of  the  account  either  of 
notes  payable  or  of  notes  receivable.  Neither  is  it  entered  on 
the  books  until  paid,  is  due  and  unpaid,  or  the  accounts  are 
closed  and  credit  is  taken  for  accrued  items,  in  accordance  with 
principles  to  be  explained  in  a  later  chapter. 

When  the  interest  is  paid  on  the  foregoing  note,  the 
transaction  is  journalized  as  follows  on  the  books  of  Joshua 
Jones: 

Interest  Expense  20 .  00 

Cash  20 .  00 

Payment  on  account  of  interest 

On  the  books  of  John  Smith,  to  whom  the  interest  is  paid, 
the  item  is  entered  as  follows: 

Cash  20.00 

Interest  Income  20 .  00 

Receipt  on  account  of  interest 

When  business  discounts  its  own  notes  before  maturity,  the 
bank  discount,  in  accordance  with  the  general  practice,  is 
treated  as  interest.  Thus,  if  John  Smith  discounts  his  own  90- 
day  note  of  $500.00  at  the  bank  at  8%  his  journal  entries 
would  be  as  follows: 

Cash  490 . 00 

Interest  Expense  k>  .  00 

Notes  Payable  500.00 

Discount  of  note  at  Valley  National 

Bank,  due  three  months  from 

date 


THE  FORM  AND   USE  OF  COMMERCIAL  PAPERS        6 1 

6.  Discount  of  Note  Receivable.  —  In  order  to  obtain  im- 
mediate cash,  a  business  frequently  discounts  its  notes  receiv- 
able before  maturity,  the  proceeds  usually  being  deposited  to 
its  credit  by  the  bank  discounting  the  paper.  When  such  dis- 
counts are  made,  the  amount  of  the  note  at  maturity  repre- 
sents the  sum  upon  which  the  discount  is  based.  Thus,  if  John 
Smith  discounts  at  6%  three  months  before  it  is  due  the 
$500.00  note  received  from  Joshua  Jones,  the  amount  to  be 
discounted  is  $520.00,  and  the  discount  amounts  to  $7.80. 

In  discounting  a  note  receivable,  however,  the  business, 
through  its  endorsement  of  the  paper,  assumes  a  contingent 
liability  for  the  payment  of  the  obligation  at  maturity;  for,  if 
the  maker  defaults,  the  endorser  becomes  liable  for  both  prin- 
cipal and  interest.  Instead  of  crediting  notes  receivable,  there- 
fore, an  entirely  new  account  is  formed,  commonly  known  as 
Notes  Receivable  Discounted.  In  consequence,  the  discount  in- 
dicated in  the  preceding  paragraph  is  debited  and  credited  by 
John  Smith  as  follows: 

Cash  512.20 

Interest  Expense  7 .  80 

Notes  Receivable  Discounted  500.00 

Interest  Income  20.00 

Discount  of  note  receivable  at  Val- 
ley National  Bank 

If  a  note  is  not  paid  at  maturity,  the  endorser  must  be  noti- 
fied at  once;  otherwise  his  liability  ceases.  If  John  Smith, 
therefore,  as  endorser  of  the  note  receivable  discounted,  re- 
ceives no  notice  of  dishonor  within  a  few  days  after  the  matur- 
ity of  the  paper,  the  discharge  of  his  contingent  liability  is  in- 
dicated by  the  following  journal  entry: 

Notes  Receivable  Discounted      500 .  00 

Notes  Receivable  500.00 

Credit  to  notes  receivable  for 
amount  of  discounted  note 
paid  by  maker  at  maturity 

Should  the  note,  however,  be  dishonored  when  it  becomes 
due,  Smith,  as  endorser,  is  obliged  to  pay  it.    Such  payment 


62 


ACCOUNTING  PRINCIPLES 


would  result,  not  only  in  a  discharge  of  his  contingent  liability 
but  in  a  claim  against  the  maker  of  the  note  for  the  principal 
and  interest.  To  cover  the  payment  of  Jones'  defaulted  note, 
Smith  therefore  makes  the  following  entries: 

Notes  Receivable  Discounted      5CX) .  oo 

Notes  Receivable  500.00 

Credit  to  notes  receivable  for 
amount  of  discounted  note  de- 
faulted by  maker  at  maturity 

Joshua  Jones  5  20 .  00 

Cash  520 . 00 

Charge  to  Jones  of  principal  and  in- 
terest of  his  defaulted  note 

If  Jones  has  meantime  become  insolvent,  the  charge  to  him 
represents,  of  course,  a  loss  or  an  expense. 

7.  Bill  of  Exchange.  —  A  bill  of  exchange,  or  a  draft,  as  it  is 
more  commonly  called,  is  an  unconditional  order  in  writing  by 
one  person  to  another,  signed  by  the  person  giving  it,  requiring 
the  person  to  whom  it  is  addressed  to  pay  to  a  third  person 
named  therein  on  demand  or  at  a  fixed  or  determinable  future 
time  a  certain  sum  of  money  to  order  or  to  bearer.  The  draft 
is  usually  made  to  order,  and  becomes  negotiable  only  through 
endorsement.    A  three-party  draft  is  shown  below. 

ILLUSTRATION  NO.  9 
Three-Party  Draft  (Accepted) 


THE  FORM  AND   USE  OF  COMMERCI.\L  PAPERS        63 

Frequently  the  maker  and  the  payee  or  the  maker  and  the 
drawee  are  the  same  party.  Where  this  is  the  case,  the  draft 
is  known  as  a  two-party  draft.  Whether  two  or  three  party, 
however,  the  drawer  usually  does  not  make  a  draft  without 
some  definite  understanding  regarding  its  acceptance  by  the 
drawee. 

8.  Time  Draft.  —  Where  a  draft  is  due  on  a  specified  date 
or  on  a  certain  number  of  days  after  date  or  presentation,  it  is 
known  as  a  time  draft,  and  is  presented  to  the  drawee  for  his 
acceptance.  If  the  drawee  accepts,  he  endorses  his  acceptance 
across  the  face  of  the  instrument,  converting  it  into  a  promis- 
sory note.     (See  Illustration  No.  9.) 

The  accepted  draft  or  acceptance  shown  in  the  preceding 
paragraph  is  therefore  journalized  as  follows: 

(a)  On  the  books  of  William  Hayes  when  the  draft  is  sent: 

John  Smith  500. co 

Joshua  Jones  500 .  00 

Draft  on  Jones  in  favor  of  Smith 

(b)  On  the  books  of  John  Smith  when  the  draft  is  accepted 
by  Joshua  Jones: 

Notes  Receivable  500 .  00 

William  Hayes  500 .  00 

Payment  of  Hayes'  account  with 
time  draft,  accepted  by  Joshua 
Jones 

(c)  On  the  books  of  Joshua  Jones  when  the  draft  is  accepted 
by  him: 

William  Hayes  500 .  00 

Notes  Payable  500.00 

Acceptance  of  30-day  draft  drawn 
by  Hayes,  due  July  31,  19 18 

Frequently  the  drawee  is  a  bank  or  other  financial  institu- 
tion.   The  principle  of  journalizing,  however,  remains  the  same. 

9.  Sight  Draft.  —  Where  a  draft  is  made  payable  at  sight,  it 
is  known  as  a  sight  draft.  Unless  abrogated  by  law,  three  days 
of  grace  are  allowed  the  drawee  in  which  to  pay  it.    Present- 


64  ACCOUNTING  PRINCIPLES 

ment  must,  therefore,  first  be  made  to  fix  maturity,  and  then 
for  payment.  In  the  matter  of  journalizing,  the  sight  draft  is 
treated  like  a  check  or  like  cash. 

ID.  Check.  —  A  check  is  a  draft  on  a  bank  payable  on  de- 
mand. Like  other  forms  of  drafts,  it  is  usually  made  to  the 
order  of  the  payee,  and  becomes  negotiable  only  through  en- 
dorsement. As  the  paid  checks  are  returned  by  the  bank  when 
the  depositor's  account  is  balanced,  the  endorsement  serves  as 
a  receipt.    The  ordinary  form  of  check  is  shown  below. 

ILLUSTRATION  NO.  lo.  —  CHECK 

Valley,  III.,  January  i ,  igig  No.  89 

THE  VALLEY  NATIONAL  BANK  OF  VALLEY,  ILLINOIS 

Pay  to  the  order  of John  Smith $520.00 

Five  Hundred  twenty  and  00/100 Dollars 

Joshua  Jones 

A  bank  draft  is  simply  the  check  of  one  bank  on  another 
bank,  and  is  payable  on  demand.  Because  of  the  financial 
standing  of  the  institution  issuing  it,  a  bank  draft  is  generally 
preferred  to  a  personal  check.  The  form  of  the  ordinary  bank 
draft  is  given  below. 

ILLUSTRATION  NO.  11.  — BANK  DRAFT 

Valley,  III.,  January  i .,  1919        No.  3 

THE  VALLEY  NATIONAL  BANK  OF  VALLEY,  ILLINOIS 

Pay  to  the  order  of John  Smith $520.00 

Five  hundred  twenty  and  00/100 Dollars 

State  National  Bank  James  Brown 


New  York  City  Cashier 

The  personal  check  and  the  bank  draft  are  both  treated  as 
cash,  and  journalized  accordingly. 

II.  Discount.  —  The  word  discount,  as  ordinarDy  used,  means 
the  amount  deducted  by  a  bank  from  the  face  of  a  note  which 
it  buys  before  maturity.    In  accounting,  this  deduction  is  en- 


THE  FORM  AND  USE  OF  COMMERCIAL  PAPERS        65 

tered  as  interest.    The  word,  however,  has  other  business  ap- 
pUcations. 

Allowances  are  generally  made  by  a  business  for  the  early 
payment  of  its  sales  invoices.  These  allowances,  known  as 
cash  discounts,  though  somewhat  similar  to  interest  or  bank 
discount,  are  entered  as  discounts  on  sales.  Thus,  if  the  Cen- 
tral Book  Company  sells  to  John  Smith  on  January  i  books  to 
the  amount  of  $250.00,  terms  2%  discount  for  cash  in  10  days, 
net  30  days,  and  Smith  pays  the  bill  on  January  5,  the  pay- 
ment is  journalized  as  follows: 

(a)  On  the  books  of  the  Central  Book  Company: 

Cash  245.00 

Discount  on  Sales  5 .  00 

John  Smith  250.00 

Receipt  of  payment  on  accovmt 

(b)  On  the  books  of  John  Smith: 

Central  Book  Company  $250.00 

Cash  $245.00 

Discount  on  Purchases  5.00 

Payment  of  account 

Frequently  trade  allowances  on  the  quoted  price  of  a  com- 
modity are  made  by  a  business  to  its  customers.  This  allow- 
ance, known  as  commercial  or  trade  discount,  is  usually  not 
entered  on  the  books  of  record.  Instead  of  a  single  discount, 
the  allowance  may  consist  of  a  series  of  discounts.  Thus,  a 
merchant  might  offer  to  his  customer  a  discount  of  20%,  10%, 
and  5%,  or  20,  10,  and  5,  on  a  bill  of  $500.00.  Such  a  quota- 
tion means  that  the  actual  purchase  price  is  to  be  found  by 
taking  20%  from  the  face  of  the  bill,  10%  from  the  balance, 
and  5%  from  the  amount  then  remaining.  The  series  may,  of 
course,  be  converted  into  a  single  discount  by  the  following 
process: 

$200  X  .80  X  .90  X  .95  =  $200  X  .684  =  $136.80 

In  fact,  the  conversion  of  the  various  percentages  into  one 
equivalent  percentage  is  the  usual  form  of  calculation. 


66  ACCOUNTING  PRINCIPLES 

12.  Time  Calculations.  —  There  are  various  methods  in  vogue 
for  the  reckoning  of  time  in  interest  calculations.  The  units  of 
time  involved  are  the  day,  the  month,  the  quarter,  the  half 
year,  and  the  year.  In  all  cases  involving  days  the  day  from 
which  should  be  excluded.  If  a  loan  is  made  on  the  first  day  of 
the  month  and  paid  on  the  tenth  day  of  the  month  and  the 
unit  of  time  is  the  day,  then  interest  is  paid  for  nine  days.- 
But  this  does  not  fully  settle  the  case.  The  next  question  is  as 
to  the  number  of  days  in  a  year.  The  interest  tables  are  gener- 
ally based  on  a  30-day  month  and  a  360-day  year.  On  such  a 
basis  the  interest  for  nine  days  would  be  9/30  or  3/10  of  the 
interest  for  one  month  or  1/40  of  the  interest  for  one  year.  In 
this  case  the  calculation  would  get  the  same  result  with  a 
month  unit  as  the  basis  as  it  would  with  the  year  unit.  In 
general  a  certain  rate  of  interest  not  qualified  is  understood  to 
mean  a  rate  per  year.  The  rate  then  for  a  half  year  is  regarded 
as  one  half  the  rate  for  the  year  although  technically,  instead 
of  multiplying  the  amount  by  1.03  for  a  half  year  of  interest 
when  the  rate  is  6  per  cent  per  amium,  the  exact  method  would 
involve  the  multiplication  of  the  principal  by  1.02956.  The 
interest  paid  at  the  half-year  period  would  itself  draw  interest 
so  that  the  lender  actually  gets  a  rate  better  than  6  per  cent  if 
he  gets  3  per  cent  of  the  principal  twice  each  year.  Likewise 
the  interest  for  one  quarter  of  the  year  is  ordinarily  taken  as 
one  fourth  of  the  interest  for  the  year. 

If  the  interest  contract  makes  the  month  the  time  unit,  one 
would  begin  with  the  date  of  the  first  day  of  the  interest  period 
and  exclude  that  day.  Then  the  day  in  the  next  month  having 
the  same  number  as  the  initial  day  of  the  period  will  be  the 
last  day  of  the  first  month.  If,  however,  the  first  day  of  such  a 
period  is  January  31,  February  28  in  a  common  year  or  Febru- 
ary 29  in  a  leap  year  will  be  the  last  day  of  the  first  month. 
In  a  common  year  the  last  day  of  the  first  month  would  be 
February  28  if  the  initial  day  were  January  28,  29,  30,  or  31. 

13.  Treasury  Method  of  Calculating  Time.  —  The  interest 
method  adopted  by  the  United  States  Treasury  is  as  follows: 

Only  one  of  the  two  days  of  the  date  and  due  date  of  an 


THE  FORM  AND   USE  OF  COMMERCIAL  PAPERS        67 

obligation  is  taken  into  accoiint  in  stating  the  time  for  which 
interest  is  to  be  calculated. 

A  month  is  to  be  regarded  as  one  twelfth  of  a  year  re- 
gardless of  the  number  of  days  it  contains.  Likewise,  a  quar- 
ter is  one  fourth  of  a  year  and  six  months  one  half  of  a  year, 
regardless  of  the  number  of  days  they  contain. 

When  an  interest  rate  is  referred  to  as  6  per  cent  or  other 
rate,  a  rate  per  annum  is  understood  to  be  implied. 

"In  calculating  interest  for  a  fractional  period,  the  time  is 
the  true  fraction  of  that  period.  For  an  annual  rate,  the  time 
is  the  exact  number  of  days  for  which  the  interest  runs,  divided 
by  the  number  of  days  in  the  year,  365  or  366;  for  a  semi-an- 
nual or  quarterly  period,  it  is  the  number  of  days  for  which  the 
interest  runs,  divided  by  the  number  of  days  in  the  particular 
half  year  or  quarter  year. 

"Unless  the  unit  period  is  a  month,  the  month  does  not  enter 
into  interest  computations,  only  days  and  the  full  unit  period 
being  considered." 

According  to  this  method  an  interest  period  of  a  year  would 
involve  in  the  case  of  calculating  interest  for  a  part  of  a  year 
the  multiplication  of  1/365  of  the  annual  interest  for  a  com- 
mon year  and  1/366  of  the  annual  interest  for  a  leap  year  by 
the  number  of  days  for  the  part  year.  The  month  would  not 
be  considered.  It  will  also  be  noted  that  if  the  quarter  is  the 
time  basis  and  the  time  in  the  quarter  is  75  days,  the  interest 
fraction  would  be  75/120  of  the  interest  for  the  quarter  if  the 
year  were  a  common  year,  or  75/121  if  the  year  were  a  leap 
year.  In  the  case  of  the  second  quarter  of  the  year  the  fraction 
would  be  75/123  of  the  interest  for  the  quarter.  The  half  year 
basis  would  be  treated  in  the  same  way  as  the  quarter  basis. 

If  a  month  were  taken  as  the  basis  a  month  would  be  defined 
as  indicated  in  paragraph  12  above.  A  fraction  of  a  month 
would  be  the  number  of  days  already  elapsed  divided  by  the 
number  of  days  in  the  month  in  question. 

14.  The  New  York  and  Massachusetts  Method.  —  In  the 
states  of  New  York  and  Massaqhusetts  a  year  is  defined  by 
law  as  consisting  of  365  days. 


68  ACCOUNTING  PRINCIPLES 

15.  Method  Recommended  for  Students.  —  In  making  cal- 
culations of  accruals  it  is  recommended  that  the  30-day  month 
and  the  360-day  year  be  adopted  for  periodic  closings  in  which 
no  transfer  of  property  is  involved.  The  net  profits  cannot  be 
an  exact  figure  since  depreciation  and  other  similar  items  must 
be  an  approximation.  The  interest  tables  could  then  be  used 
in  the  periodic  closings  and  much  time  saved. 

When  transfers  of  property  are  involved  or  interest  payments 
must  be  made  it  seems  preferable  to  adopt  the  method  pre- 
scribed by  law  of  the  state  in  which  the  contract  is  made.  The 
calculations  of  interest  for  any  fraction  of  a  year  would  then 
be  made  according  to  the  method  adopted  by  the  treasury  de- 
partment in  common  year  calculations.  The  interest  due  on 
60  and  90  day  notes  at  maturity  would  be  60/365  or  90/365  of 
the  interest  for  a  year  if  365  days  were  defined  as  the  year. 

In  those  states  where  the  Law  Merchant  is  adopted  and  not 
modified  by  special  statute,  such  as  the  state  of  Texas  and 
many  other  states,  the  30-day  month  and  the  360-day  year  is 
adopted  as  the  basis  of  the  calculations.  Interest  calculations 
in  Texas  both  for  accruals  and  for  actual  interest  payments 
should  be  made  on  the  basis  of  the  30-day  month  and  the  360- 
day  year. 

16.  Corrections  of  Table  Calculations.  —  If  interest  has  been 
calculated  on  a  360-day  basis  a  change  may  be  made  to  a  365- 
day  basis  by  subtracting  1/73  of  the  interest  calculated  on  the 
former  basis.  If  the  interest  has  been  calculated  on  a  365-day 
basis,  it  may  be  changed  to  a  360-day  basis  by  adding  1/72  of 
the  interest  calculated  on  the  former  basis. 

PROBLEMS  AND   QUESTIONS 

1.  Why  is  it  cxistomary  to  make  arrangements  in  advance  for  drawing  a 
three-party  draft? 

2.  Why  do  some  business  men  very  much  disUke  to  have  drafts  drawn  on 
them? 

3.  What  is  the  most  frequent  use  to  which  the  two-party  draft  is  now  put? 

4.  You  ship  merchandise  amounting  to  $260.00  to  Cotter  &  Hines,  of 
Center\iew,  and  draw  a  sight  draft  on  them,  which  is  attached  to  the  bill 
of  lading  and  deposited  in  your  bank  for  collection.  Give  the  entries  on 
your  books  and  on  those  of  Cotter  &  Hines. 


THE  FORM  AND  USE  OF  COMMERCIAL  PAPERS        69 

5.  You  draw  on  the  Young  Mercantile  Co.  at  sight  for  $300.00  and  place 
the  draft  in  your  bank  for  collection,  receiving  credit  for  that  amount.  The 
draft  is  not  honored  upon  presentation.  What  entries  on  your  books  are 
then  necessary? 

6.  You  receive  an  invoice  of  $263.00  from  the  Newman  Cloak  Co.  of 
Chicago,  and  at  the  bank  pay  this  amount  on  a  sight  draft,  to  which  the  bill 
of  lading  is  attached.     Give  the  entries. 

7.  You  discount  at  the  Valley  National  Bank  at  8%  a  $600.00  note 
receivable  payable  without  interest,  three  months  from  the  date  on  which 
the  discount  is  made.     Journalize  the  transaction. 

The  maker  of  the  note  defaults  when  the  note  becomes  due,  and 
you  are  called  on  to  pay  it.     Make  the  necessary  journal  entries. 

You  discoimt  at  the  VaUey  National  Bank  at  5%  three  months 
before  maturity  a  $500.00  note  receivable  due  six  months  after  date,  with 
interest  at  6%.     Journalize  the  transaction. 

The  note  is  paid  at  maturity,  no  notice  of  dishonor  being  received. 
Make  the  proper  entry. 

8.  You  draw  at  10  days'  sight  on  Peters  &  White,  of  Chicago,  for  $500.00 
in  favor  of  the  Chicago  House  Furnishing  Co.  What  are  the  entries  of  each 
party  concerned  if  the  draft  is  accepted  two  days  later;  if  the  draft 
is  dishonored;  if  the  draft  is  paid  at  maturity;  if  because  of  lack  of 
ffmds  the  draft  is  not  paid  at  maturity? 

9.  Draw  on  the  Emmons  Hardware  Co.  at  30  days'  sight  for  $500.00. 
Give  the  entries  of  both  parties  if  the  draft  is  accepted;  if  it  is  paid 
at  maturity.  What  would  be  done  if  the  Hardware  Company  refuses  to 
accept  the  draft? 

10.  On  January  i,  you  purchase  a  bill  of  goods  amounting  to  $300.00, 
terms  2/10,  n/30.  On  January  3  you  return  $50.00  worth  for  credit.  What 
amoimt  of  cash  will  settle  the  bill  on  January-  11? 

11.  From  what  date  does  the  discount  period  begin  to  run  —  the  date 
of  the  invoice,  the  date  of  the  shipment  of  the  goods,  or  the  date  of  the  re- 
ceipt of  the  goods? 

12.  Is  it  the  practice  to  mail  checks  out  on  the  last  day  of  discount  or  to 
mail  them  in  time  so  that  they  will  reach  their  destination  on  the  last  day  of 
discoimt? 

13.  WTiat  is  the  purpose  of  the  custom  of  dating  invoices  ahead,  i.e., 
post-dating?  For  example,  a  bill  of  millinery  bought  in  July  and  shipped 
from  the  factory  on  August  i  may  be  accompanied  by  an  invoice  dated 
September  i. 

14.  You  buy  a  bill  of  goods  on  July  i  amounting  to  S500.00,  terms 
2/10,  n/30.  Not  having  the  necessary  cash  on  July  11  to  pay  the  bill,  you 
borrow  money  at  6%  to  take  advantage  of  the  discount.  How  much  do 
you  gain  or  lose  by  the  transaction? 

15.  You  purchase  a  bill  of  goods  from  John  Smith  on  October  i,  terms 
2/10,  n/30.  On  October  11  you  are  unable  to  pay  the  entire  bill,  but  by 
arrangement  with  Smith  you  are  to  be  allowed  the  discount  on  whatever 
portion  of  the  bill  you  can  meet.  If  you  send  Smith  a  check  for  $245.00, 
how  much  credit  will  }ou  receive? 


70  ACCOUNTING  PRINCIPLES 

i6.  On  Sqjtember  i,  you  purchase  goods  amounting  to  $2,000.00,  terms 
2/10,  n/30.  You  have  $2000.00  in  the  savings  bank  with  which  to  meet  the 
bill.  This  money  is  drawing  4^,  but  must  remain  in  the  bank  untU  Oc- 
tober I,  or  else  all  interest  since  the  last  interest  computation  day,  July  i, 
will  be  forfeited.  You  have  your  choice,  therefore,  of  the  following  waj-s  of 
paying  your  bill:  (a)  You  may  let  the  bill  run  until  October  i,  forfeiting  the 
discount  but  retaining  the  interest  on  your  savings  account;  (b)  you  may 
withdraw  your  savings  and  pay  the  bill  on  the  discount  date;  (c)  you  may 
borrow  the  money  on  your  note  for  20  daj-s  at  6%  and  pay  the  bill  on  the 
discount  date,     ^\^lich  plan  is  the  best,  and  by  what  amoimt? 

17.  Why  do  wholesale  firms  use  a  series  of  discounts,  such  as  25%,  20%, 
and  5%,  instead  of  a  single  discount,  such  as  50%? 

18.  Which  is  the  better  and  how  much — a  series  of  25%,  20%,  and  10%, 
or  a  single  discount  of  50%? 

19.  One  firm  offers  a  piano  for  $400.00,  subject  to  discounts  of  20%  and 
20%,  and  another  offers  the  same  make  of  piano  with  25%  and  15%  off  list. 
Which  is  the  better  offer,  and  by  how  much? 

20.  Find  a  single  rate  of  discount  equal  to  a  discount  series  of  50%,  25%, 
20%,  and  10%. 

21.  Find  the  net  selling  price  of  an  oak  sideboard  listed  at  $125.00,  less 
25%.  33H%,  and  10%. 


CHAPTER  VI 
THE   DIVroED   JOURNAL  AND   THE  TRADING  ACCOUNT 

1.  Character  of  Entries  in  a  Merchandise  Business.  —  A  re- 
view of  the  problems  and  exercises  contained  in  the  preceding 
chapter  will  show  that  nearly  fifty  per  cent  of  the  items  have 
been  posted  to  the  cash  account,  the  merchandise  account,  and 
the  sales  account.  Moreover,  for  each  transaction  involving 
any  of  these  accounts,  there  have  been  two  postings  —  one  to 
cash,  merchandise,  or  sales,  and  one  to  the  other  account  in- 
volved in  each  case.  Manifestly,  economy  of  time  and  effort 
would  result  if  the  number  of  postings  could  be  reduced. 

This  could  be  accomplished  to  a  degree  by  collecting  the 
various  debits  and  credits  to  these  accounts  and  recording  them 
as  a  compound  entry  in  the  general  journal,  thus: 


Cash 

500.00 

Sales 

200.00 

John  Smith 

200.00 

Notes  Receivable 

50.00 

Interest  Income 

50.00 

Merchandise 

400.00 

Wages 

150.00 

Office  Expense 

50.00 

Interest  Expense 

100.00 

Notes  Payable 

300.00 

Cash 

1,000.00 

The  first  compound  journal  entry  above  indicates  how  ac- 
counts having  the  same  debit  may  be  grouped  together  so  that 
there  will  be  only  one  debit  posting  whereas  there  would  be 
four  without  the  grouping  accomplished  by  the  compound 
entry.  Likewise  the  second  compound  entry  by  grouping  the 
accounts  having  a  common  credit  account  will  require  only  one 
credit  posting  instead  of  five  which  would  be  required  without 
the  grouping.    If  a  journal  were  selected  which  would  contain 

71 


72  ACCOUNTING  PRINCIPLES 

only  cash  items  and  all  credit  accounts  having  cash  as  a  corre- 
sponding debit  were  placed  on  one  page  and  all  debit  accounts 
having  cash  as  the  offsetting  credit  were  placed  on  the  right 
page,  the  charge  and  credit  to  cash  could  themselves  be  omitted. 
(See  Illustration  Xo.  12  below.)  The  appearance  of  accounts 
to  be  credited  on  the  debit  page  (left  page)  of  such  a  cash  jour- 
nal would  be  a  sufficient  indication  that  cash  was  to  be  debited 
for  the  total  of  amounts  credited  to  these  accounts.  Likewise 
the  appearance  of  accounts  on  the  credit  (right)  page  of  such  a 
journal  would  be  a  sufficient  indication  that  cash  was  to  be 
credited  for  an  amount  equal  to  the  total  of  the  amounts  set 
opposite  these  accounts. 

2.  Cash  Journal.  —  The  cash  journal  may  consist  of  paper 
with  the  ordinary  journal  ruling,  the  debits  being  entered  on 
the  even  pages  (left  pages)  and  the  credits  on  the  odd  pages 
(right  pages).  For  a  particular  period,  therefore,  the  debit 
entries  are  on  the  left  and  the  credits  on  the  opposite  page  or 
the  right.    (See  Illustration  No.  12.) 

As  the  sum  of  the  debit  entries  less  the  sum  of  the  credit  en- 
tries is  equal  to  the  amount  of  cash  on  hand,  provided  the  bal- 
ance at  the  beginning  is  entered  as  the  first  debit,  the  cash 
journal  can  be  used  to  show  the  cash  balance  at  any  time,  and 
nothing  is  gained  by  retaining  a  cash  account  in  the  ledger. 
The  cash  journal  becomes,  therefore,  not  only  a  book  of  orig- 
inal entry,  but  a  ledger  account  as  well. 

3.  Purchase  Journal.  —  It  might  seem  logical  to  use  a  simi- 
lar journal  for  the  merchandise  account,  with  purchases  as 
debits  on  the  left  and  sales  as  credits  on  the  right,  and  with  the 
merchandise  inventory  at  the  beginning  as  the  first  debit  to 
the  account.  The  sum  of  the  debit  entries  less  the  sum  of  the 
credit  entries  does  not,  however,  give  the  balance  of  merchan- 
dise. Consequently,  there  is  no  particular  advantage  in  enter- 
ing purchases  and  sales  in  the  same  journal.  On  the  other 
hand,  as  in  a  large  business  the  recording  of  purchases  is  the 
work  of  one  clerk  and  the  recording  of  sales  is  the  work  of  an- 
other, there  is  a  distinct  gain  in  having  separate  books  of  orig- 
inal entr)^  for  purchases  and  for  sales. 


DIVIDED  JOURNAL  AND  TRADING  ACCOUNT  73 

In  the  purchase  journal  are  entered  all  purchases  of  mer- 
chandise as  made,  together  with  the  account  to  be  credited  in 
each  particular  case.  As  cash  purchases  are  entered  in  both 
the  purchase  journal  and  the  cash  journal,  as  a  debit  in  one 
and  a  credit  in  the  other,  no  record  of  the  account  to  be  cred- 
ited in  the  first  journal  or  debited  in  the  second  journal  need 
be  made.  After  cash  purchases  have  been  entered  in  each  jour- 
nal, however,  the  entries  in  both  should  be  checked  in  the 
folio  columns  to  indicate  that  no  necessary  posting  has  been 
omitted.  The  unchecked  items  in  the  purchase  journal  are 
then  posted  to  the  proper  accounts,  and  a  periodic  closing  is 
made,  the  total  purchases  being  entered  as  a  debit  to  the 
merchandise  purchases  account,  which  is  explained  in  a  later 
paragraph  on  the  trading  account. 

Purchases  of  property  other  than  merchandise  are  not  en- 
tered in  the  purchase  journal,  but  in  the  old,  or,  as  it  may  now 
be  called,  the  general  journal.  Such  a  differentiation  is,  of  course, 
necessary.  The  total  of  purchases  is  used  in  the  calculation  of 
the  gross  profits  arising  from  operation,  and  would  fail  of  its  pur- 
pose if  purchases  of  items  not  intended  for  sale  were  included. 

4.  Sales  Journal.  —  The  ruling  of  the  sales  journal  is  similar 
to  that  of  the  cash  and  purchase  journals.  In  the  sales  journal 
are  entered  all  sales  of  merchandise  as  made,  together  with  the 
account  to  be  debited  in  each  transaction.  This  debit  account 
is,  however,  unnecessary  in  cash  sales,  which,  like  cash  pur- 
chases, are  entered  in  both  the  sales  journal  and  the  cash  jour- 
nal, the  debit  entries  of  the  latter  constituting  the  credit  en- 
tries of  the  former.  After  checking  the  corresponding  items  in 
the  two  journals  to  indicate  that  tKe  proper  cross-entries  in  the 
cash  journal  and  the  sales  journal  have  been  made,  the  un- 
checked entries  in  the  sales  journal  are  posted  to  the  proper 
accounts.  As  in  the  case  of  the  purchase  journal,  a  closing  is 
periodically  made,  the  total  of  the  sales  being  carried  to  the 
credit  of  the  merchandise  sales  account  in  the  ledger. 

5.  General  Ledger.  —  Although  relieved  of  more  than  sev- 
enty-five per  cent  of  the  original  entries  by  means  of  the  special 
journals  indicated,  the  general  journal  still  serves  a  useful  pur- 


74  ACCOUNTING  PRINCIPLES 

pose.  In  it  are  recorded  the  opening  entries  of  a  business  for 
assets  and  liabilities  contributed  to  it  or  taken  over  by  it, 
these  assets  and  liabilities  being  Usted  as  the  debits  and  credits 
of  a  compound  journal  entr>\  WTiere  cash  forms  all  of  the  as- 
sets, the  opening  entry  is  made  simply  in  the  cash  journal;  but, 
where  cash  is  only  one  of  a  niunber  of  assets,  the  cash  item  is 
entered  in  both  the  cash  journal  and  the  general  journal,  the 
two  entries  being  checked  to  indicate  that  the  proper  cross- 
en  tr\'  has  been  made. 

In  the  general  journal,  also,  are  recorded  the  closing  entries 
of  the  revenue  accounts  in  connection  with  the  formation  of 
the  profit  and  loss  account,  and  the  closing  entry  of  the  latter 
in  connection  with  the  transfer  of  its  balance  to  the  capital  ac- 
count, as  well  as  adjustment  entries,  credit  purchases  of  expense 
items,  credit  purchases  of  property  items,  and  all  other  entries 
not  belonging  to  any  of  the  sp)ecial  journals  aheady  described. 

6.  Trading  Account.  —  The  trading  account  is  practically  a 
reconstruction  of  the  old  merchandise  account,  which  was  de- 
stroyed, of  course,  through  the  formation  of  the  merchandise 
purchases  and  the  merchandise  sales  accounts.  Unlike  the  old 
merchandise  accovmt,  however,  the  trading  account  consists  of 
totals  rather  than  of  individual  items.  To  the  trading  account 
are  debited  the  merchandise  inventory'  at  the  beginning  of  the 
period  and  the  balance  of  the  merchandise  purchases  account 
for  the  period  under  consideration;  while  to  it  are  credited  the 
balance  of  the  merchandise  sales  account  for  the  interval  and 
the  merchandise  inventory  at  the  close  of  the  period.  The  bal- 
ance of  the  account,  as  in  the  old  merchandise  account,  repre- 
sents the  gross  profits,  which  are  closed  into  profit  and  loss. 
The  trading  account,  therefore,  may  be  said  to  bear  the  same 
relation  to  the  merchandise  purchases  and  merchandise  sales 
accounts  that  profit  and  loss  bears  to  the  revenue  accounts. 

7.  Return  Purchases  and  Allowances.  —  WTiere  merchandise 
is  returned  by  a  business  on  account,  or  allowances  are  made 
on  merchandise  purchases,  entries  are  made  in  the  general  jour- 
nal to  the  debit  of  the  seller  and  to  the  credit  of  the  merchan- 
dise purchases  account.    Consequently,  the  balance  of  the  mer- 


DIVIDED  JOURNAL  AND  TRADING  ACCOUNT  75 

chandise  purchases  account  represents  the  net  purchases,  and  is 
the  amount  to  be  debited  to  the  trading  account. 

If  the  number  of  items  of  return  purchases  and  allowances  is 
large  a  separate  account  may  be  set  up  and  closed  into  mer- 
chandise purchases  or  trading  when  the  books  are  closed. 

8.  Return  Sales  and  Allowances.  —  The  return  of  goods  to 
a  business,  or  allowances  made  by  it  on  merchandise  sales,  are 
also  entered  in  the  general  journal,  the  transactions  being  deb- 
ited to  the  merchandise  sales  account  and  credited  to  the  cus- 
tomers involved.  The  balance  of  the  merchandise  sales  ac- 
count, therefore,  represents  the  net  sales,  and  is  entered  as  a 
credit  to  the  trading  account. 

If  the  number  of  items  of  return  sales  and  allowances  is  large, 
a  separate  account  may  be  carried  and  closed  into  merchandise 
sales  or  trading  at  the  time  of  closing  the  books. 

9.  Invoices  as  Original  Entries.  —  Purchase  invoices  are  fre- 
quently bound,  or  pasted  in  a  bound  book,  and  used  as  a  pur- 
chase journal.  The  sellers  are  then  credited  by  postings  direct 
to  the  ledger,  the  total  of  the  invoices  for  a  given  period  con- 
stituting the  debit  to  the  merchandise  purchases  account. 

Sales  invoices  are  also  frequently  used  as  a  sales  journal. 
Where  this  is  the  case,  the  invoices  are  printed,  bound,  and 
numbered  in  duplicate,  the  originals  being  sent  to  the  buyers 
and  the  duplicates  constituting  a  bound  book  of  original  entry, 
from  which  the  individual  debits  are  posted  and  the  total  credit 
to  merchandise  sales  is  taken. 

10.  Treatment  of  Discount  n  Special  Journals.  —  When  an 
invoice  is  sent  or  received,  the  gross  amount  of  the  invoice  is 
entered  in  the  sales  journal  or  in  the  purchase  journal,  as  the 
case  may  be,  the  amount  being  later  debited  or  credited  to  the 
proper  account.  When  paid,  the  gross  amount  of  the  invoice 
is  entered  on  the  proper  side  of  the  cash  journal,  together  with 
the  name  of  the  customer  from  whom  payment  is  received  or 
the  name  of  the  creditor  to  whom  remittance  is  made.  The 
discount  is  entered  on  the  opposite  side  of  the  ledger,  becoming 
a  discount  on  sales  in  the  case  of  a  sales  invoice  and  a  discount 
on  purchases  in  the  case  of  a  purchase  invoice.    Thus,  the  full 


76  ACCOUNTESTG   PRINCIPLES 

amount  of  a  sales  invoice  is  entered  as  a  debit  to  cash,  the  dis- 
count becoming  a  credit  to  cash  under  the  designation  of  dis- 
counts on  sales.  Conversely,  the  gross  amount  of  a  purchase 
invoice  is  entered  on  the  credit  side  of  the  cash  journal,  the 
discount  in  this  case  becoming  a  debit  to  cash  under  the  head- 
ing of  discovmts  on  purchases.  The  result  is  a  correct  cash  bal- 
ance and  a  correct  debit  or  credit  of  the  full  amount  of  the  in- 
voice to  the  proper  personal  account.  This  style  of  entering 
discounts  is  not  used  in  the  columnar  journals  to  be  treated  in 
a  succeeding  chapter. 

II.  Illustration.  —  The  illustration  below  will  show  in  detail 
the  method  of  recording  merchandise  transactions  by  means  of 
the  divided  journals  described  above.  The  transactions  in- 
volved precede  the  illustrated  account  entries. 

o  TKANSACnONS  FOR  ILLUSTRATION  No.    12 

IQiS 

Mar.  I  Russell  Scott  opens  business  with  the  following  assets: 
cash,  $1600.00;  merchandise,  $2000.00;  store  fix- 
tvires,  $500.00. 

2  Buys  merchandise  to  the  amount  of  $600.00  from  the 

Emporium  on  account,  terms  2/10,  n/30. 

3  Pays  freight  charges  in  cash  amounting  to  $14.00     Sells 

merchandise  to  Henry  Waddell  on  accoimt  to  the 
amount  of  $240.00. 

4  Buys  two  horses  and  a  wagon  from  the  City  Sales  Co.  for 

$300.00,  giving  a  60-day  note  in  p>ayment. 

5  Cash  sales,  $150.00.     Sells  Edward  Lange  on  accoimt  mer- 

chandise to  the  amount  of  $250.00. 

6  Buys  a  lot  and  small  store  building  from  the  Reuter  Realty 

Co.  for  $2000.00.  paying  $800.00  cash  and  giving  a 
one-year  note  for  the  balance. 

8  Cash  sales,  $1 20.00.     Bu>'s  on  account  from  the  Emporium 

merchandise  amoimting  to  $750.00,  terms  2/10,  n/30. 

9  Sells   Henry  Waddell   on   accoimt  merchandise   to   the 

amount  of  $325.00.  Pays  insurance  on  store  build- 
ing, fixtures,  and  stock,  amounting  to  $26.00. 

10  Cash  sales,  $135.00.     Ta.ys  the  Emporium  bill  of  March  2 

in  full  by  remitting  $588.00  in  cash. 

1 1  Buys  a  cash  register  from  the  National  Cash  Register  Co. 

for  $200.00,  giving  a  1 5-day  note,  bearing  6%  interest 
in  payment.  Sells  Edward  Lange  on  account  mer- 
chandise to  the  amount  of  $150.00. 


DIVIDED  JOURNAL  AND  TRADING  ACCOUNT  77 

Mar.    12     Buys  hay  and  other  stable  supplies  for  $75.00  cash. 

13  Pays  for  postage,  stationery,  and  other  store  expenses 
$32.00  in  cash.  Pays  store  salaries  for  two  weeks, 
amounting  to  $50.00. 

15  Cash  sales,  $126.00. 

16  Henry  Waddell  pays  $200.00  cash  on  account  and  gives 

a  60-day  note  for  $300.00.     Credit  of  $10.00  allowed 
Waddell  on  account  for  merchandise  returned. 

17  Pays  the  Emporium  bill  of  March  8,  taking  the  discount. 

1 8  Sells  Henry  Waddell  on  account  merchandise  amounting 

to  $225.00. 

19  Buys  from  the  Emporium,  2/15,  n/30,  merchandise  to  the 

amount  of  $950.00. 

20  Sells  Edward  Lange  on  account  merchandise  amounting  to 

$175.00.     Returns  $18.00  worth  of  damaged  goods  to 
the  Emporium  for  credit. 

22  Pays  cash  for  sundry  store  expenses  amounting  to  $15.00. 

23  Cash  sales,  $260.00. 

24  Edward  Lange  pays  $200.00  on  account,  and  is  allowed 

$50.00  additional  credit  in  exchange  for  harness  for 
delivery  team. 

25  The  Emporium  allows  credit  of  $25.00  for  damage  to  mer- 

chandise bought  on  March  19. 

26  Pays  note  to  National  Cash  Register  Co.,  due  today,  with 

$.50  interest. 

27  Pays  store  salaries  for  two  weeks,  $50.00.  and  sundry 

store  expenses  amounting  to  $32.00. 

28  Sells  Henry  Waddell  on  account  merchandise  amoimting 

to  $185.00. 

30  Pays  the  wages  of  the  driver  of  the  delivery  truck  amount- 
ing to  $37.50.  Returns  $25.00  worth  of  merchandise 
to  the  Emporium  for  credit.  Allows  credit  of  $15.00 
to  Henry  Waddell  for  goods  returned. 

30    Merchandise  inventory,  $2,785.00. 

Accounts  to  be  kept:  Russell  Scott,  capital:  Russell  Scott,  per- 
sonal; merchandise  purchases;  merchandise  sales;  merchandise  in- 
ventory; store  fixtures;  delivery  equipment;  freight  in;  notes 
receivable;  notes  payable;  real  estate;  insurance;  discount  on 
sales;  discount  on  purchases;  delivery  expense;  store  expense;  in- 
terest; personal  accounts  as  needed. 

Make  the  original  entries,  post,  and  take  a  trial  balance. 

Close  the  revenue  accounts  into  profit  and  loss,  and  profit  and  loss 
and  Russell  Scott,  personal,  into  capital. 

Close  the  books,  and  take  another  trial  balance  after  closing. 


78 


ACCOUNTING  PRINCIPLES 


Dr. 


ILLUSTRATION  NO.  12 
The  Divided  Journal 

Cash 


I9I8 

Mar. 

1 

Original  Investment 

V 

1600 

00 

5 

Cash  Sales 

V 

150 

00 

8 

Cash  Sales 

V 

120 

00 

10 

Cash  Sales 

V 

135 

00 

Discount  on  Purchases 

88 

12 

00 

IS 

Cash  Sales 

V 

12600 

16 

Henr>-  WaddeU 

Paid  on  account 

84 

200 

00 

17 

Discount  on  Purchases 

88 

IS 

00 

23 

Cash  Sales 

V 

260 

00 

24 

Edward  Lange 

Paid  on  account 

84 

200 

00 

""^ 

281S 

00 

Mat. 

31 

Balance 

136 

00 

Cash 


Cr. 


I9IS 

Mar. 

3 

Freight  In 

88 

14 

00 

6 

Real  Estate 

Part  Pay.  Lot  and  Bldg. 

85 

800 

00 

Q 

Insurance 

Bldg.,  FLx.  and  Stock 

87 

26 

00 

10 

Emporium 

Invoice  Mar.  2 

86 

600 

CO 

12 

Delivery  Expense 

Hay  and  Other  Stable 

Sups. 

881 

7S 

00 

13 

Store  Expense 

Postage,  Stationery,  etc. 

87 

32 

CO 

Store  Expense 

Store  Salaries 

87 

SO 

00 

17 

Emporium 

Invoice  Mar.  8 

86 

7SO 

00 

22 

Store  Expense 

Sundries 

87 

IS 

00 

26 

Notes  Payable 

Nat'l  Cash  Reg.  Note 

m 

200 

00 

Interest 

Nat'l  Cash  Reg.  Note 

86 

50 

27 

Store  Expense 

Store  Salaries 

87 

SO 

00 

Store  Expense 

Sundries 

87 

32 

00 

30 

Delivery  Expense 

Wages  Truck  Driver 

88 

37 

so 

Balance 

136 

00 

2818 

00 

J 

DIVIDED  JOURNAL  AND  TRADING  ACCOUNT 
Purchases  f 


79 


I9I8 

Mar. 

2 

Emporiiun 

Inv.  540,2/10,11/30 

86 

600 

00 

8 

Emporium 

Inv.  690,2/io,n/3o 

86 

7SO 

00 

19 
_32 

Emporium 
Merchandise  Purchases 

Inv.  972, 2/15, n/60 
— Total  Purchases 

86 

87 

950 

00 

2300 

00 

Sales 


I9I8 

Mar. 

I 

Henr>  WaddeU 

Inv.  10 

84 

240 

00 

5 

Cash  Sales 

V 

ISO 

00 

Edward  Lange 

Inv.  114 

84 

250 

00 

8 

Cash  Sales 

V 

120 

00 

9 

Henry  WaddeU 

Inv.  260 

84 

325 

00 

Cash  Sales 

V 

135 

00 

II 

Edward  Lange 

Inv. 319 

84 

ISO 

00 

15 

Cash  Sales 

V 

126 

00 

18 

Henry  WaddeU 

Inv.  629 

84 

225 

00 

20 

Edward  Lange 

Inv.  63s 

84 

17s 

00 

22, 

Cash  Sales 

V 

260 

00 

28 
30 

Henry  WaddeU 
Merchandise  Sales — 

Inv,  1059 
Total  Sales 

84 
87 

185 

00 

2341 

00 

So 


ACCOUNTING  PRINCIPLES 


GENERAL  JOURNAL 
March,  19  i8 


Cash 

Merchandise  Inventory- 
Store  Fixtures 

Russell  Scott,  Capital 
Original  investment 


Delivery  Equipment 

Notes  Payable 
Sixty-day  note  for  horse  and  wagon 


Real  Estate 

Notes  Payable 
One-year  note  for  balance  lot  and  bldg. 


Store  Fixtures 

Notes  Payable 
Fifteen-day  note  to  Natl  Cash  Roister 
Co.  for  cash  register 


16 

Notes  Receivable 
Henry  Waddell 
Sixty-day  note  on  accoimt 


17 
Merchandise  Sales 
Henry  Waddell 
Credit  for  merchandise  returned 


Emporium 

Merchandise  Purchases 
Allowance  for  damaged  goods  returned 

Carried  Fonvard 


1600 

2000 

500 


00 
00 
00 


4100 


300 « 


300 


300  < 


300  < 


.GO 


18  < 


18  < 


6l28|ooj    6128  ( 


DIVIDED  JOURNAL  AND  TRADING  ACCOUNT  8 1 


Brought  Forward 


24 


8S 
84 


86 
87 


86 
87 


87 
84 


85 


88 


Delivery  Equipment 

Edward  Lange 
Allowance  on  account  for  harness 


25 

Emporium 

Merchandise  Purchases 
Allowance  for  damaged  goods  returned 


30 

Emporium 

Merchandise  Purchases 
Merchandise  returned 


Merchandise  Sales 
Henry  Waddell 
Credit  for  merchandise  returned 


Closing  Entries 

March  30 

Trading — ^Mdse.  Inv.  Beginning  of  period 

Mdse.  Inv. — Trading 
Closing  of  Mdse.  Inv.  beginning  of  period 
into  trading 

Trading — Net  Purchases 

Merchandise  Purchases  —  Net  Pur. 
Closing  of   merchandise  purchases  into 
trading 

Trading  —  Freight  In 

Freight  In — Trading 
Closing  of  freight  in  into  trading 


6128 


50 


25 


25 


15 


6243 


2232 


14 


612S  00 


50 


25 


25 


15 


6243 


2232 


14 


82 


ACCOUNTING  PRINCIPLES 


87    Merchandise  Sales — Net  Sales 
Trading — Net  Sales 
Closing  of  merchandise  sales  into  trading 


85    Mdse.  Inv.  End  of  Period — Trading 
Trading — Mdse.  Inv.  End  of  Period 
Entry  of  merchandise  inventory  end  of 
the  period 


Trading  —  Gross  Profits 
89        Profit  and  Loss  —  Gross  Profits 
Closing  of  trading  into  profit  and  loss 


89    Profit  and  Loss — Store  Expense 
87        Store  Expense — Profit  and  Loss 

Closing  of  store  expense  into  profit  and 


89    Profit  and  Loss — Delivery  Exp)ense 
Delivery  Expense — Profit  and  Loss 
Closing  of  delivery  expense  into  profit 
and  loss 


89   Profit  and  Loss — ^Interest 
88         Interest — Profit  and  Loss 

Closing  of  interest  into  profit  and  loss 


89    Profit  and  Loss  —  Insurance 
87  Insurance  —  Profit  and  Loss 

Closing  of  insurance  into  profit  and  loss 


88  Discount  on  Purchases  —  Profit  and  Loss 

89  Profit  and  Loss  —  Disc,  on  Pur. 
Closing   of   discount  on  purchases  into 

profit  and  loss 


89   Profit  and  Loss  —  Net  Profits 
86  Ru^ll  Scott,  Capital  —  Net  Profits 

Closing  of  profit  and  loss  into  capital 


23^61 


2785 


855 


179  < 


50 


50 


260  ( 


27 


564' 


2316  ( 


27S5 


85s 


179 


50 


50 


26 


27 


564" 


DIVIDED  JOURNAL  AND  TRADING  ACCOUNT 


83 


The  closing  entries  are  made  in  detail  above.  The  related 
entries  may  be  combined  into  compound  journal  entries,  and 
the  closing  entries  abbreviated  as  follows: 


GENERAL  JOURNAL 
March,  19 18 


Closing  Entries 

March  30 

Trading 

Mdse.  Inv.  Beginning  of  Period 

Merchandise  Purchases 

Freight  In 
Closing  of  the  merchandise  accounts  into 
trading 

Sales 

Mdse.  Inv.  End  of  Period 
Trading 

Trading  —  Gross  Profits 

Profit  and  Loss  —  Gross  Profits 
Closing  of  trading  into  profit  and  loss 

Profit  and  Loss 

Store  Expense 

Delivery  Expense 

Interest  Paid 

Insurance 
Closing  the  expense  accounts  into  profit 
and  loss 

Discount  on  Purchases  —  Profit  and  Loss 
Profit  and  Loss  —  Discount  on  Pur. 
Closing   of   discount   on   purchases   into 
profit  and  loss 

Profit  and  Loss  —  Net  Profits 

Russell  Scott,  Capital  —  Net  Profits 
Closing  of  profit  and  loss  into  capital 


424s 


2316 
2785 


855 


318 


564 


2000 

2232 

14 


5101 


8SS 


179 
112 


26 


27 


564 


84 


ACCOUNTING  PRINCIPLES 


LEDGER  OF  RUSSELL  SCOTT 
Notes  Receivable 


F 

F 

I9I8 

Mar. 

16 

Balance 

J80 

300 

00 

1918 
Mar. 

30 

Balance 

300 

00 

Mar. 

31 

300 

00 

Henry  Waddell 


I9I8 

Mar. 

I 

9 

18 

28 

Mar. 

31 

Balance 


S79 

240 

00 

I9I8 
Mar. 

16 

S79 

325 

00 

S79 

225 

00 

17 

S79 

i8s 

00 

30 

= 

975 
450 

cx> 
cx> 

Balance 


300 


J80     10 


J81 


IS 

450 


975 


00 
00 
00 
00 


Edward  Lange 


I9I8 
Mar. 

5 

S79 

250 

00 

1918 
Mar. 

24 

C78 

200 

cx> 

II 

S79 

150 

00 

J81 

50 

00 

20 

S79 

175 

00 

30 

Balance 

325 

00 

^575 

00 

575 

00 

Mar. 

31 

Balance 

32s 

00 

DIVIDED  JOURNAL  AND  TRADING  ACCOUNT 


85 


Merchandise  Inventory 

F 

F 

1918 

Mar. 

I 
31 

Inventory 
Inventory 

J80 
J82 

2000 

00 

I9I8 

Mar. 

30 

Trading 

J82 

2000 

00 

2785 

00 

Delivery  Equipment 

1918 
Mar. 

4 
24 

J80 
J81 

300 

so 

00 
00 

1918 
Mar. 

30 

Balance 

350 

00 

Balance 

= 

35° 
350 

00 

CX3 

= 

350 

00 

Mar. 

31 

Store  Fixtures 

1918 
Mar. 

I 
II 

J80 
J80 

500 

200 
700 

00 
00 
00 

1918 
Mar. 

30 

Balance 

700 

700 

00 

00 

Mar. 

31 

Balance 

700 

00 

Real  Estate 

1918 
Mar. 

6 

J80 

C78 

1200 

800 

2000 

CO- 

00 
00 

1918 
Mar. 

30 

Balance 

2000 

2000 

00 

CX) 

Mar. 

31 

Balance 

2000 

00 

86 


ACCOUNTING  PRINCIPLES 
Notes  Payable 


1918 
Mar. 


Balance 


C78 

200 

00 

I9I8 

Mar. 

4 

1500 

00 

6 
II 

I7CX3 

00 

Mar. 

31 

Balance 


J80 

300 

J80 

1200 

J80 

200 

== 

1700 

1500 

E.MPORIUM 


I9I8 

Mar. 

10 

C78 

600 

00 

IQI8 

Mar. 

2 

P79 

6cx> 

00 

17 

C78 

750 

00 

8 

P79 

750 

00 

20 

J80 

18 

00 

19 

P79 

950 

00 

25 

J81 

25 

00 

30 

Balance 

J81 

! 

25 

882 

00 
00 

2300 

00 

2300 

00 

Mar. 

31 

Balance 

882 

00 

Russell  Scott,  Capital 


I9I8 
Mar. 

30 

Balance 

4664 

4664 

00 

00 

1918 
Mar. 

I 
30 

Net  Profits 
Balance 

J80 
J82 

4100 

564 

4664 

4664 

CX5 

00 

Mar. 

31 

00 

DIVIDED  JOURNAL  AND  TRADING  ACCOUNT 


87 


F 

Insurance 

F 

I9I8 

Mar. 

_Q 

C78 

26 

00 

I9I8 

Mar. 

30 

Profit  &  Loss 

|82 

26 

00 

II              1       1 

Merchandise  Sales 

1918 
Mar. 

17 
30 

Net  Sales 

J80 
J81 
J82 

10 

15 
2316 

2341 

00 
00 
00 
00 

1918 
Mar. 

30 

S79 

2341 
2341 

00 
00 

]V 

Ierchandise  Purc 

hases 

1918 
Mar. 

30 

P79 

2300 
2300 

00 

CX) 

1918 
Mar. 

20 

25 

30 

NetPurchases 

J8I 
J8I 
J8I 
J8I 

18 

25 
25 

2232 
2300 

00 
00 
00 
00 

00 

Store  EyENSE 

1918 
Mar. 

13 

22 
27 

C78 
C78 
C78 
C78 
C78 

32 
50 
15 
so 
32 

00 
00 
00 

CX) 

00 

1918 
Mar. 

30 

Profit  &  Loss 

J82 

179 

00 

1 79 

00 

179 

00 

88 


ACCOUNTING  PRINCIPLES 
Delivery  Expense 


1918 
Mar. 


30 


C78 

75 

00 

1918 
Mar. 

30 

C78 

37 

50^ 

|lI2 

50 

Profit  &  Loss 


J82 


SO 


SO 


Discount  on  Purchases 


1918 
Mar. 


30 


Profit  &  Loss 


C78 
C78 


IS 


00 
00 


27 


Freight  In 


1918 
Mar. 


CI4 

14 

00 

I9I8 

Mar. 

30 

Trading 


J81 


14' 


Interest  Expense 


1918 
Mar. 


26 


C78 


•50 


1918 
Mar. 


30 


Profit  &  Loss 


J82 


SO 


Trading 


1918 
Mar. 


30 


Mdse.  Inv. 

J81 

2000 

00 

1918 
Mar. 

30 

NetPurchases 

J81 

2232 

00 

Freight  In 

J81 

14 

00 

Gross  Profits 

J82 

8SS 

00 

Sioi 

00 

Net  Sales 
Mdse.  Inv. 


J82 
J82 


2316 
2785 


DIVIDED  JOURNAL  AND  TRADING  ACCOUNT  89 

„  Profit  and  Loss  „ 


1918 
Mar. 


30 


Store  Exp. 

J82 

179 

00 

1918 
Mar. 

30 

Deliv.  Exp. 

J82 

112 

50 

InterestExp. 

50 

Insurance 

J82 

26 

00 

Net  Profits 

J82 

564 

00 



882 

00 

Gross  Profits 
Disc,  on  Pur. 


J82 
J82 


855 
27 


PROBLEMS  AND    QUESTIONS 

I.  Make  a  cash  journal,  general  journal,  purchase  journal,  and  sales 
journal  from  ordinary  journal  paper.  Enter  the  transactions  listed  below, 
post  them  to  the  ledger,  take  a  trial  balance,  and  close  the  accoimts. 


1918 
Mar. 


John  Smith  begins  a  coal  business  by  turning  over  the  following: 
Building,  $1500.00;  land,  $1200.00;  cash,  $250.00;  furniture 
and  fixtures,  $300.00.  The  land  and  building  have  a  mort- 
gage payable  outstanding  against  them  to  the  amount  of 
$750.00. 

Buys  from  the  Central  Coal  Co.,  7  tons  of  nut  coal  at  $8.00  a 
ton  and  10  tons  of  liunp  coal  at  $7.00  a  ton,  2/10,  n/30. 

Sells  to  J.  T.  Sanders  on  account  3  tons  of  nut  coal  at  $11.00  a 
ton;  to  M.  H.  Borders  on  account  5  tons  of  lump  coal  at 
$10.00  a  ton;  and  to  Walter  Love  for  cash  2  tons  of  nut  coal 
at  $10.50  a  ton. 

Receives  invoice  from  the  Valley  Coal  Co.  for  the  following 
items: 

5  Tons  Mine  Run  Coal,  at  $6.00  a  ton  (2000  lbs.) 

6  Tons  Lump  Coal,  at  $7.00  a  ton 
4  Tons  Nut  Coal,  at  $8.00  a  ton 


$30.00 
42.00 
32.00 
$104.00 


Upon  weighing,  there  are  found  the  following  shortages: 

200  lbs.  Mine  Run  Coal,  100  lbs.  Liunp  Coal,  and 

200  lbs.  Nut  Coal. 
Sales  as  follows : 

M.  H.  Borders,  4  tons  Nut,  at  $11.00  a  ton,  2/10,  n/30. 

R.  N.  Johnson,  3  tons  Lump,  at  $10.00  a  ton,  cash. 

Valley  Hotel,  3  tons  Mine  Run,  at  $8.00  a  ton,  2/10,  n/30. 


90  ACCOUNTING  PRINCIPLES 

Purchases  as  follows: 
Valley  Coal  Co.,  2/10,  n/30: 
10  Tons  Nut,  at  $9.00. 
4  Tons  Lump,  at  $7.00. 
6  Tons  Mine  Run,  at  $7.00. 
On  receipt  of  the  coal,  it  is  discovered  from  samples  to  be  of  in- 
ferior quaUty,  and  an  allowance  of  $7.75  is  made  by  the  Valley 
Coal  Co. 
Mar.    6    John  Smith  decides  to  invest  $1000.00  additional  in  the  business, 
and  spends  $900.00  of  this  for  the  construction  of  coal  bins 
and  loading  facilities.     He  then  hires  day  laborers  to  shovel 
coal  into  the  bins,  pa\ing  them  $25.00  for  their  services. 
He  spends  $10.00  additional  in  repairs  to  the  building. 
The  following  amounts  are  paid  on  account: 

Invoice  of  March  2  of  Central  Coal  Co.,  less  discoimt. 
Invoice  of  ^larch  5  of  \'alley  Coal  Co.,  less  discount. 

7  Collections  as  follows: 

J.  T.  Sanders,  $33.00. 

M.  H.  Borders,  $50.00. 

Valley  Hotel,  $23.52,  amount  of  bill  of  March,  less  the  discount. 

8  Sales  as  follows* 

Valley  Hotel,  6  tons  Mine  Run,  at  S8.00  a  ton  on  account. 

Central  Hotel,  5  tons  Nut,  at  S10.50,  cash. 

Capital  Boarding  Club,  4  tons  Lump,  at  $10.00  on  accoimt. 

9  Purchases  as  follows: 

Central  Coal  Co.  on  account : 
20  Tons  Nut,  at  $7.75. 
30  Tons  Lump,  at  $7.00. 
25  Tons  Mine  Run,  at  $7.00. 

10  Sales  as  follows: 

Central  Manufacturing  Co.,  10  tons  Mine  Run,  at  $8.00  on 

account. 
Central  Hotel,  5  tons  Nut,  at  S10.50,  cash. 
Valley  Liunber  Mills,  8  tons  Lump,  at  $10.00,  on  account. 

11  The  VaUey  Lumber  Mills  reject  one  ton  of  coal  on  accoimt  of 

inferior  quality,  and  return  it  for  credit. 
I  12    The  Central  Manufacturing  Co.  makes  a  note  for  $80.00  for  3 
months  at  8%  in  settlement  of  its  account. 

13  John  Smith  discounts  the  note  at  7%  at  the  Valley  National 

Bank. 

14  Pays  the  V^alley  Coal  Co.  in  full  for  purchases  of  March  4. 
Receives  pajTiients  as  follows  on  account : 

Valley  Hotel,  $48.00. 
Capital  Boarding  Club,  $40.00. 
Makes  the  following  pa>Tnents: 
Office  Salaries,  $175.00. 
Stationer\'  and  other  office  expanses,  $25.00. 

15  Calculate  the  balances  of  the  accounts  and  check  the  entries, 

then  take  a  trial  balance.     The  business  has  S400.00  worth 
of  coal  on  hand.     Close  the  accounts  through  the  journal. 


DIVIDED  JOURNAL  AND  TRADING  ACCOUNT  91 

2.  What  per  cent  of  the  postings  required  by  the  regular  journal  is 
saved  for  items  entered  in  (a)  the  cash  journal;  (b)  the  purchase  journal; 
(c)  the  sales  journal?  About  what  per  cent  of  the  total  transactions  are 
entered  in  these  special  journals? 

3.  What  economy  other  than  that  in  posting  results  from  the  use  of  the 
special  journals? 

4.  Compare  the  trading  account  with  the  merchandise  account. 

5.  Make  a  trading  account  from  the  following  items: 

Merchandise  at  the  beginning  of  the  Period  $1,500.00 

Merchandise  Purchases  10,500.00 

Merchandise  Sales  15,000.00 

Return  Purchases  250.00 

Return  Sales  150.0C) 

Freight  In  35- 00 

Office  Expense  50 .  00 

Merchandise  on  Hand  at  Close  of  Period  1,400.00 

6.  The  balance  of  each  account  on  the  books  of  Samuel  J.  Smith,  hard- 
ware merchant,  on  September  30  follows: 

(a)  Construct  the  trial  balance. 

(b)  The  merchandise  inventory  on  September  30th  was  $8700.00. 

Construct  a  statement  of  Losses  and  Gains  and  a  Financial 
Statement. 

(c)  Give  the  journal  entries  to  close  the  books : 

*  Accounts  Payable  $2,500.00 

'Accounts  Receivable  5,200.00 

Cash  5,075.00 

Commission  Earned  500.00 

Delivery  Equipment  2,000.00 

Delivery  Expense  3 75  •  00 

Expense  700 . 00 

Heat  and  Light  500 .  00 

Interest  Earned  250.00 

Merchandise  Purchases  30,800 .  00 

Merchandise  Sales  29,700.00 

Mortgage  Paj'able  4,000.00 

Notes  Payable  3,000.00 

Notes  Receivable  2,000.00 

Real  Estate  8,000.00 

Salaries  2,800.00 

Samuel  Smith,  Capital  18,000.00 

Samuel  Smith,  Personal  300 .  00 

Taxes  200 .  00 

*  These  items  are  the  sums  of  amounts  owing  by  debtors  and  owing  to  creditors. 


CHAPTER  Vn 

JANUARY  TRANSACTIONS  OF  THE  VALLEY  FURNITURE 

STORE 

Illustrating  the  Use  of  Special  Journals 

I.  Taking  Over  the  Urban  Furniture  Co.  —  On  January  i, 
1914,  Frank  Williams  starts  into  the  furniture  business  under 
the  firm  name  of  Valley  Furniture  Store.  He  takes  over  the 
assets  and  assumes  the  liabilities  of  the  Urban  Furniture  Co. 
on  the  basis  of  the  following  statement,  prepared  by  Erwin 
Beckman  &  Co.,  Certified  Public  Accountants,  paying  out  of 
his  own  personal  assets  $23,275.00  to  John  Smith,  the  owner  of 
the  Urban  Furniture  Co. 

Balance  Sheet  of  Urban  Furniture  Co.,  December  31,  1913 

Assets 


Cash 

$500.00 

Accounts  Receivable: 

5,000.00 

St.  Luke's  Hospital   - 

$1,000.00 

Bagdad  University 

2,000.00 

Rice  Mfg.  Co. 

500.00 

Smith  Institute 

600.00 

J.  H.  Brigham 

400.00 

K.  C.  Riley 

500.00 

Merchandise  Inventory 

22,275.00 

Fixtures 

1,000.00 

Delivery  Equipment 

3,000.00 

$31,77500 

Liabilities  and  Proprietorship 

Notes  Payable  $1,000.00 

(Note  in  favor  of  the  Grand  Rapids  Fum. 
Co.,  dated  Jan.  9,  1913,  for  i  yr.) 
Accoimts  Payable  7,500.00 

Sheboygan  Chair  Co.  $2,400.00 

Michigan  Bed  Co.  1,000.00 

Wilson  Carpet  Works  2 , 1 00 .  00 

Haywood  Fum.  Co.  2,000.00 

John  Smith,  Capital  23,275.00       $31,775.00 

92 


TRANSACTIONS  OF  VALLEY  FURNITURE   STORE        93 

It  was  also  provided  that  the  building  of  the  Urban  Furni- 
ture Co.  should  be  leased  from  Chester  Allen,  the  owner,  for 
the  year  at  $100.00  per  month.  (No  entry  is  made  in  the  jour- 
nal in  regard  to  this  lease.) 

2.  Order  of  Accounts  in  the  Ledger.  —  After  the  opening  en- 
tries are  made  in  the  general  journal,  these  opening  entries  are 
posted  to  the  ledger.  Before  this  posting  is  made,  however,  it 
is  necessary  to  determine  the  accounts  which  are  to  be  kept  in 
the  operation  of  the  books  of  the  Va'ley  Furniture  Store. 

The  accounts  to  be  kept  are  classified  below,  mainly  with 
reference  to  the  order  which  they  are  to  take  in  the  ledger. 
The  ledger  order  is  dictated  mainly  by  the  order  in  which 
the  several  accounts  appear  in  the  balance  sheet  and  revenue 
statement  which  are  to  be  made  at  the  end  of  the  month 
of  January.  If  the  accounts  in  the  trial  balance  have  the 
same  order  as  that  given  the  accounts  in  the  ledger,  the  trial 
balance  can  show  the  accounts  in  the  same  order  as  they  are 
shown  in  the  ledger  and  they  can  be  taken  off  in  regular  order 
in  connection  with  the  preparation  of  the  balance  sheet  and 
the  revenue  statement.  The  classification,  however,  is  not 
the  order  in  which  the  accounts  would  appear  in  a  ledger  index 
which  shows  the  accounts  listed  alphabetically.  There  should 
appear  as  the  first  page  of  every  ledger,  an  index  to  the  ledger 
accounts.  The  following  classification  of  accounts  will  be  used 
for  the  Valley  Furniture  Store  during  the  month  of  January. 

A.    Assets 

1.  Cash  (as  per  Cash  Book) 

2.  Accounts  Receivable  Page 

(a)  Bagdad  University i 

(b)  J.  H.  Brigham i 

(c)  H.  R.  Caldwell i 

(d)  J.  Collins 2 

(e)  Foster  Hall 2 

(f)  Rice  Mfg.  Co 2 

(g)  K.  C.Riley 3 

(h)  St.  Luke's  Hospital 3 

(i)  Smith  Institute 3 

(j)  Square's  (H.  P.)  Business  College       ....  4 


94  ACCOUNTING  PRINCIPLES 

Page 

(k)    H.  P.  Henderson 4 

(1)     H.  R.  Scjtt 4 

(m)  R.  H.  Thompson 5 

(n)    Wm.  Ward 5 

(o)    Wm.  Day 5 

(p)    Hotel  Bismarck 6 

3.  Merchandise  Inventory 6 

4.  Scrap 6 

5.  Supply  Invs 7 

6.  Deferred  Exp 7 

7.  Store  and  Office  Fixts 7 

8.  Deprec.  Res.  for  Fixts 8 

9.  DeHvery  Equipment 8 

10.  Depreciation  Reserve  for  Equipment 8 

11.  Land 9 

12.  Buildings 9 

13.  Depreciation  Reserve  for  Buildings 9 

B.    Liabilities  and  Proprietorship 

1.  Notes  Payable 10 

2.  Accounts  Payable 

(a)  Cross  Farming  Co 10 

(b)  Haywood  Furniture  Co ' .      .      .10 

(c)  Michigan  Bed  Co 11 

(d)  Wilson  Carpet  Co 11 

(e)  Sheboygan  Chair  Co 11 

(f)  Loey  Lock  and  Safe  Co 12 

(g)  Sample  Fur  Co 12 

(h)  Underwood  Typewriter 12 

3.  Proprietorship 

(a)    Frank  Williams,  Capital 13 

C.    Revenue  Accounts 

1.  Income  Accoimts  (not  a  Ledger  Account) 

(a)  Merchandise  Sales 13 

(b)  Sales  Returns  and  Allowances 13 

(c)  Financial  (not  a  Ledger  Account) 

(i)  Discoimt  on  Purchases 13 

(2)  Interest  Income 14 

2.  Exi)ense 

(a)  Merchandise  Purchases 14 

(b)  Purchase  Rets,  and  Allow 14 


TRANSACTIONS  OF  VALLEY   FURNITURE   STORE        95 

(c)  Administrative  (not  a  Ledger  Account)  Page 

(i)  Salaries 15 

(2)  Miscellaneous  Admin 15 

(d)  Selling  Expense  (not  a  Ledger  Account) 

(i)  Advertising 16 

(2)  Salaries 16 

(3)  Miscellaneous  Selling  Expense      .      .      .     .16 

(e)  Delivery  Expense 17 

(f)  Financial  (not  a  Ledger  Account) 

(i)  Interest  Expense 17 

(2)  Discount  on  Sales 17 

(g)  General  Expense  (not  a  Ledger  Account) 

(i)  Depreciation .18 

(2)  Miscellaneous 18 

(3)  Over  and  Short 18 

D.     Closing  Accounts 

1.  Trading 19 

2.  Profit  and  Loss 19 

3.  Groups  of  Accounts.  —  It  will  be  noticed  in  the  classifi- 
cation given  above,  that  a  certain  number  of  captions  represent 
the  title  of  accounting  groups,  instead  of  ledger  accounts. 
Considering  the  use  made  of  the  balance  sheet,  it  is  advan- 
tageous to  have  all  the  customer  accounts  in  one  total  under 
the  caption  of  accounts  receivable,  as  well  as  to  have  a  list  of 
the  detail  customer  accounts.  There  is,  therefore,  found  a 
group  caption  to  the  customer  accounts  when  they  appear  in  a 
balance  sheet.  The  same  explanation  can  be  made  with  the 
caption  for  the  group  of  accounts  payable.  The  heading  of 
proprietorship,  under  which  is  listed  the  account  of  Frank  Wil- 
liams, marks  this  account  off  from  the  group  of  definite  liabil- 
ities, so  that  it  will  be  understood  to  be  a  type  of  obligation 
of  the  business,  different  from  that  which  is  represented  by 
promises  to  pay  definite  sums  of  money  at  specific  times,  or 
obligations  to  pay  certain  accounts  at  stated  times.  The  pro- 
prietorship claim  against  the  assets  of  a  business  is  a  claim 
in  perpetuity  and  is  never  paid  in  full  unless  the  business 
itself  is  liquidated. 

It  will  also  be  noted  that  certain  groups  of  accounts  appear 


96  ACCOUNTING  PRINCIPLES 

under  the  heading  of  revenue  accounts.  The  financial  group 
of  income  accounts  represents  earnings  due  to  efficient  financial 
services,  and  from  investments  incidental  to  the  main  busi- 
ness. The  expense  accounts  are  grouped  according  to  the  serv- 
ices rendered  and  follow  in  general  the  lines  of  division  of 
labor  in  the  business  itself.  There  will  ordinarily  be  one  or 
more  employees  whose  attention  is  devoted  to  administration; 
some  employees  whose  attention  is  given  to  selling;  others  who 
are  charged  with  the  delivery  service.  Then,  there  will  be  the 
general  financial  expenses  such  as  interest  and  discount  on 
sales.  The  general  expense  accoimt  is  meant  to  contain  all 
those  items  not  otherwise  classified.  If  at  any  time  the  amount 
of  a  sundr>'  item  not  otherwise  classified,  becomes  large,  the 
general  expense  account  would  become  the  name  of  a  group 
of  accounts  and  would  be  split  up  into  the  cost  of  services  ren- 
dered, under  the  caption  of  general  expense.  For  example, 
rent,  janitor  services,  cost  of  heat  and  light,  might  become  the 
names  of  separate  accounts  instead  of  being  charged  to  gen- 
eral expense,  if  the  total  expenditure  under  these  captions 
were  large  in  amount. 

The  reason  for  the  grouping  of  expense  accounts  is  found  in 
the  explanation  of  why  the  accounts  should  be  set  up  in  the 
first  place.  There  will,  in  general,  be  a  standard  expense  under 
the  caption  of  the  cost  of  the  several  services  which  are  recog- 
nized as  distinct.  This  standard  expense  may  grow  out  of  the 
experience  of  the  manager  of  the  business,  or  it  may  grow  out 
of  the  experience  of  others  who  have  been  engaged  in  the  same 
business.  It  will  in  general  be  recognized  that  administrative 
expense  should  not  be  more  than  a  certain  per  cent  of  total 
sales;  that  selling  expense  should  not  be  more  than  a  certain 
per  cent  of  gross  sales,  and  likewise  for  other  expenses.  It  will, 
likewise,  be  recognized  that  there  should  be  some  proportion 
between  advertising  and  the  total  of  selling  expense.  After  ah, 
then,  the  record  of  costs  is  to  be  used  by  the  manager  in  check- 
ing up  to  discover  the  points  at  which  his  business  may  be  in- 
efficient, and  the  points  at  which  it  is  regarded  as  particularly 
efficient.    Moreover,  since  the  groups  of  expenses  follow  along 


TRANSACTIONS  OF  VALLEY  FURNITURE  STORE   97 

the  lines  of  division  of  labor,  they  serve  to  enable  the  manager 
to  hold  certain  individuals  responsible  for  efficient  service  and 
also  place  him  in  position  to  reward  them  for  efficient  service. 

4.  Closing  Accounts.  —  The  closing  accounts  serve  the  pur- 
pose of  collecting  the  incomes  and  expenses  with  a  view  to  cal- 
culating the  net  increase  in  proprietorship,  which  is  carried  to 
the  credit  of  the  capital  account  of  the  owner. 

5.  Payroll.  —  The  weekly  payroll  of  the  Valley  Furniture 
Store  from  January  i,  was  as  follows: 


Frank  Williams,  Manager 
H.  P.  McCulloch,  Salesman 
J.  R.  James,  Bookkeeper 
R.  P.  Ranger,  Driver 
John  Moulton,  Office  Boy 

$100.00 

25.00 

30.00 

10.00 

7.00 

Total 

$172.00 

All  of  the  employes  are  directly  responsible  to  the  manager, 
who  can  employ  or  dismiss  the  working  force  at  his  discretion. 

6.  Erasures.  —  There  are  to  be  no  erasures  in  this  set  of 
books.  If  an  error  has  been  made  in  journalizing,  it  can  be 
corrected  by  a  journal  entry.  For  example,  suppose  that  by 
mistake,  a  sale  of  $5.00  of  merchandise  on  time  were  charged 
to  the  accoimt  of  John  Smith,  when  it  should  have  been 
charged  to  William  Jones.  The  correcting  entry  will  be: 

William  Jones  5 .  00 

John  Smith  •  5.00 

Correcting  an  error  on  July  5  in  charging  a  sale  to 
Smith  instead  of  Jones 

In  the  memorandum  space  of  the  original  entry,  there  should 
be  a  reference  to  the  correcting  entry  as  follows:  "Corrected 
by  entry  July  5." 

7.  Journal  Memoranda  for  the  Books  of  the  Valley  Furni- 
ture Store.  —  In  the  various  journals  for  the  transactions  in 
January,  the  student  will  not  be  required  to  copy  the  detail 
either  from  the  purchase  invoices  or  from  the  sales  slips.  The 
Valley  Furniture  Store  will  be  assumed  to  keep  a  set  of  pur- 
chase invoices  numbered  serially  to  which  it  can  refer  by  num- 


98  ACCOUNTING  PRINCIPLES 

ber  in  the  purchase  journal  and  on  the  credit  side  of  the  cash 
journal.  The  sales  slips  are  also  filed  serially  and  referred  to 
for  detail  in  the  sales  journal.  This  reference  to  the  original 
basis  of  the  entry  will  serve  for  memoranda  in  entering  the 
January  transactions.  There  should  always  appear  on  the 
credit  side  of  the  cash  journal  the  name  of  the  payee  and  the 
check  number  for  each  payment.  If  the  name  of  the  payee  is 
the  account  also,  it  need  not  be  entered  in  the  memorandum 
space.  In  any  case,  the  check  number  should  appear  to  the 
right  of  the  center  line  dividing  the  account  space  from  the 
memorandum  space.  The  sales  slip  number  and  the  invoice 
number  would  appear  in  the  same  place  in  the  sales  journal 
and  in  the  purchase  journal,  respectively. 

8.  Ledger  Memoranda.  —  Discount  terms  should  always  be 
entered  in  the  memorandum  space  of  the  ledger  account.  As 
indicated  in  Chapter  VI,  the  special  journals  for  sales  and  pur- 
chases are  frequently  so  combined  with  the  invoices,  that  a 
page  reference  is  also  a  reference  to  the  original  invoice.  When 
a  note  payable  is  made  or  a  note  receivable  is  received,  there 
should  be  entered  in  the  memorandum  space  of  the  general 
journal,  the  rate  of  interest,  the  due  date,  the  name  of  the 
maker,  the  name  of  the  indorsers,  and  the  date  of  the  note. 
When  a  special  bill  book  for  notes  receivable  and  notes  pay- 
able is  used  a  reference  to  this  book  may  displace  the  detailed 
memoranda.  The  general  principle  is  that  the  journals  should 
either  have  in  them  full  information  about  each  transaction  or 
should  refer  to  original  records  which  are  readily  accessible  for 
full  information.  If  it  is  feasible  to  make  the  original  records 
serve  as  journals,  this  is  desirable.  The  ledger,  on  the  other 
hand,  should  have  a  reference  to  the  journal  and  such  infor- 
mation as  the  business  will  require  in  connection  with  settling 
and  receipting  for  accounts. 

The  summary  accounts  made  for  the  purpose  of  showing 
profits  and  the  condition  of  the  business,  have  full  memoranda 
in  the  ledger  and  also  refer  to  the  journal.  When  these  ac- 
counts are  referred  to  by  the  manager  or  others  who  may  be 
interested,  the  name  of  each  account  appearing  on  the  debit  or 


TRANSACTIONS  OF  VALLEY  FURNITURE   STORE        99 

credit  side  of  the  trading  account,  the  profit  and  loss,  or  the 
balance  sheet  is  needed  to  convey  the  meaning  of  the  sum- 
mary. 
9.   Transactions  for  January. 

January  i,  1914.  To  provide  working  capital,  Mr.  Frank  Williams 
invests  $5,000.00  cash  in  addition  to  the  assets  taken  over  from  the 
Urban  Furniture  Co. 

January  2.  It  is  assumed  in  the  January  transactions  that  all 
money  received  is  deposited  in  bank.  The  cash  journal,  conse- 
quently, takes  the  place  of  an  account  with  the  bank. 

Goods  are  ordered  from  the  Haywood  Furniture  Co.  to  the  amount 
of  $1150.00,  and  a  duplicate  of  the  order  is  duly  filed.  (No  entry  is 
made  at  this  point.)     Bills  are  paid  as  follows: 

Check  #  I.   John  Smith  for  2  tons  Oklahoma  coal      $14.00 
Check  #  2.    Chester  Allen,  rent  of  store  100.00 

Check  #  3.    Corner  Book  Store,  for  stationery  20.00 

January  3.     Pay  the  following  bill  with  Check  #  4: 

J.  P.  Johnson  for  shoeing  horses  and  repairs  to  wagon  $1 2 .  00 

The  goods  ordered  from  the  Haywood  Furniture  Co.  on  the  2nd  arrive 
together  with  the  invoice.  Terms,  2%  10  days,  net  30  days,  invoice  #1. 

(The  goods  as  received  are  checked  up  with  the  invoice  in 
order  to  detect  any  discrepancies.  The  purchase  of  the  goods 
is  then  recorded  in  the  Purchase  Journal.  The  terms  quoted 
mean  that  the  account  is  payable  in  30  days,  but  that  a  dis- 
count of  2%  from  the  face  of  the  invoice  will  be  allowed  for 
payment  within  10  days  from  the  date  of  the  invoice.  Since 
there  is  no  assurance  that  the  discount  will  be  taken,  the  pur- 
chases are  entered  at  the  face  of  the  invoice.) 

January  4.  The  store  is  opened  for  business  and  the  following 
sales  are  made: 

To  H.  R.  Caldwell,  sales  slip  #1  $45.00 

Terms:  3%  10  days,  net  30  days. 
To  H.  P.  Square  Business  College,  sales  slip  #2,  $125.00. 

Terms:  Net  30  days,  8%  interest  after  30  days. 

January  5.  Cash  sales  for  the  day  are  $130.00  —  Sales  slips  #3-6. 
(One  entry  for  the  daily  cash  sales  is  sufficient.)  Allowance  is  made 
for  damage  on  the  H.  P.  Square  Business  College  order,  $20.00. 

Mr.  Williams  withdraws  Cash,  $50.00  (check  #11).  (Charge  to 
Frank  Williams,  Personal.) 


lOO  ACCOUNTING  PRINCIPLES        , 

(Full  details  of  each  sale  may  be  placed  in  the  journal,  but  the 
better  business  practice  is  to  make  out  the  sales  slips  in  dupli-* 
cate,  filing  one  copy.    The  explanation  in  the  journal  may  then 
be  merely  a  reference  to  the  number  of  the  sales  slip  and  a 
statement  of  the  terms  of  the  sale.) 

January  5.  Pay  the  Haywood  Furniture  Co.,  check  #5,  their  bill 
of  January  3,  taking  the  discount. 

(The  check  is  made  out  for  $1127,00.  By  the  payment  of  this 
amount  a  debit  of  $1150.00  is  canceled.  An  analysis  of  the 
transaction  shows  that  a  liability  to  pay  a  creditor  $1150.00 
has  been  canceled;  that  the  asset  Cash  has  been  reduced 
$1127.00;  that  for  prompt  payment  a  reward  of  $23.00  has  been 
earned.    In  the  form  of  a  journal  entry  the  analysis  becomes: 

The  Haywood  Furniture  Co.  $1,150.00 

Cash  $1,127.00 

Discoiuit  on  Purchases  23 .  00 

Smce  the  transaction  involves  the  payment  of  cash,  it  is  not 
logical  to  make  the  entry  in  the  journal.  If  the  cash  element  of 
the  transaction  is  entered  in  the  Cash  Journal  and  the  discount 
in  the  General  Journal,  the  debit  to  the  Haywood  Furn.  Co.  is 
split  into  two  parts.  If  the  transaction  is  considered  as  a  pay- 
ment of  the  face  of  the  bill  to  the  creditor,  and  a  refund  of  the 
amount  of  the  discount  from  him,  the  journalization  becomes: 


The  Haywood  Furniture  Co. 

$1,150.00 

Cash 

$1,150.00 

Cash 

23.00 

Discount  on  Purchases 

23.00 

In  this  form  the  transaction  can  be  entered  in  full  in  the 
Cash  Journal.  It  is  evident  that  the  difference  between  the 
cash  credit  and  the  cash  debit  is  $1127.00,  the  amount  of  the 
check.  For  convenience  in  auditing  the  books,  the  amount  of 
the  check  should  be  stated  in  the  explanation  space  in  the 
credit  entry,  and  reference  made  to  the  debit  entry.  In  the 
later  months  this  somewhat  cumbersome  arrangement  will  be 
avoided  by  the  use  of  special  columns.) 


TRANSACTIONS  OF  VALLEY  FURNITURE   STORE      lOI 

Pay  the  weekly  payroll  with  checks  No.  6010. 
Charge  part  of  payroll  to  administrative  salaries  and  part  to 
selling  salaries. 

January  6.  The  St.  Luke  Hospital  pays  on  account,  $500.00. 
They  also  purchase,  sales  slip  #7,  beds  amounting  to  $100.00.  H.  R. 
Caldwell  pays  his  bill  of  Jan.  4,  taking  the  discount  of  3%,  amount- 
ing to  $1.35. 

(Read  the  explanation  on  Jan.  5  again,  and  make  a  similar 
analysis  of  this  transaction.  Notice  that  in  this  case  the  discount 
is  a  Discount  on  Sales  and  is,  therefore,  a  loss  to  the  business.) 

Purchase  on  account  from  the  Sample  Furniture  Co.  for  office  use 
the  following: 

2  high  chairs  at  $5.00  $10.00 

2  high  desks  at  $20.00  40.00 

I  high  stool  2 .  00 

Terms:  2%  10  days,  net  30  days. 

$52.00 

January  8.     Purchase  on  account  from  the  Cross  Farming  Co.  a 
pair  of  mules  for  delivery  service,  $400.00. 
Sales  for  the  day: 

Cash  sales  (one  entry)  Sales  Slips  #8,  #9,  #10  —  $125.00. 
Credit  Sales: 
Foster  Hall,  Sales  Slip  #11,  Dining  room  set  $40.00 

Miscellaneous  rugs  35  •  00 

$7S-oo 

January  9.  A  rug  sold  to  Foster  Hall  on  the  8th  is  returned  for 
credit,  $20.00. 

Frank  WilUams  purchased  at  cost  for  his  personal  use  rugs  costing 
$50.00.     (Charge  to  Frank  Williams,  Sales  Slip  #12.) 

Personal  and  credit  to  Mdse.  Purchases.  Paid  interest  due  on 
notes  payable,  $80.00.  Also  paid  the  note  of  $1,000.00.  Check  #12 
covers  both  transactions.  (Although  one  check  covers  both  transac- 
tions, separate  entries  are  required  in  the  Cash  Journal.)  Buy  hay 
for  $20.00,  paying  cash.  (Check  #13.)  Mr.  Williams  increases  the 
capital  invested  in  the  business  by  $500.00,  cash. 

January  10.     Cash  Sales: 

Sales  slip  #13  $15.00 

Sales  slip  #14  10.00 

Sales  slip  #15  12.50 

Sales  slip  #16  8.00 

$45-50 


I02  ACCOUNTING  PRINCIPLES 

January  lO    Credit  Sales: 

Sales  slip  #17     Bagdad  University  $40.00 

Sales  slip  #18    J.  H.  Brigham  30.00 

Sales  slip  #19    H.  R.  Caldwell  20.00 

S90.00 
Receipts  on  account: 

Bagdad  University,  account  of  Jan.  10,  1913,  $2,000.00.     This  ac- 
count had  run  for  one  year  after  it  was  due  and  bore  interest  after 
maturity  at  the  rate  of  6^^  per  annum.     The  interest,  amounting  to 
$120.00,  is  paid  as  well  as  the  amount  of  the  account. 
January  11.     Make  payments  on  account  as  follows: 

Sheboygan  Chair  Co..  Check  #14  $2,400.00 

Michigan  Bed  Co.,  Check  #15  1,000.00 

Cash  Sales: 
Sales  slip  #20  32.00 

Sales  slip  #21  26.00 

Sales  slip  #22  •  35  00 

GckkIs  on  sales  slip  #20  are  damaged  in  deliver}'  to  the  amount  of 
S25.00.     Refund  for  this  amount  is  made  in  cash  (check  #16). 
Credit  Sales: 
Sales  slip  §2^,  H.  R.  Scott  $33.00 

Sales  slip  #24,  J.  Colhns  18.00 

Sales  slip  #25,  WiUiam  Wood  55  00 

Terms  in  all  cases,  2%  10  days,  net  30  days. 
(Since  the  terms  quoted  above  are  the  usual  terms  of  sale  in  this 
business,  they  will  be  called  regular  terras  hereafter.) 

January  12.  Make  an  agreement  with  the  Stechert  Advertising 
Agency  to  have  five  insertions  in  the  \'alley  News  at  $50.00  per  page. 
Pay  for  a  half  page  insertion,  $25.00.     (Check  #17.) 

Frank  WiUiams  draws  for  personal  use,  $50.00.     (Check  #18.) 
Pay  taxes,  $275.00.     (Check  #19.) 

Pay  the  personal  taxes  of  Frank  Williams,  $125.00.     (Check  #20.) 
The  St.  Luke  Hospital  sends  a  check  for  $98.00  in  settlement  of 
their  bill  of  Jan.  6.     As  the  terms  of  sale  did  not  provide  for  a  cash 
discount  on  this  bill,  the  check  is  returned.     (No  entr>-  required.) 
Cash  Sales: 
Sales  slip  #26  $34 .  00 

Sales  sUp  ijtay  19.00 

Credit  Sales: 
Sales  slip  #28,  William  Day  45 .  00 

Sales  slip  #29,  R.  H.  Thompson  15  00 

Sales  sUp  #30,  R.  P.  Henderson 
Terms:  Regular  in  each  case  (2%  10  days,  30  net). 
The  St.  Luke  Hospital  sends  a  check  for  $100.00,  which  is  accepted. 


TRANSACTIONS  OF  VALLEY  FURNITURE   STORE      1 03 

January  13.     The  Sample  Furniture  Co.  is  closing  out  business. 
Take  advantage  of  the  low  prices  offered  on  their  stock  to  order  the 
following  goods,  terms:  settlement  on  delivery.     Order  merchandise 
to  the  amount  of  $1,850.00.     (No  entry  required  at  this  time.) 
January  13.     Cash  Sales: 

Sales  slip  #31  $25.00 

Sales  slip  #32  17  50 

Sales  slip  §2>3  22.00 

Sales  slip  #34  38 .  00 

$IC2.50 

Credit  Sales: 
Sales  sUp  #35,  J.  Collins  $25.00 

Terms,  3%  10  days. 
Sales  slip  #36,  H.  R.  Caldwell  30.00 

Sales  slip  #37,  J.  H.  Brigham  30.00 

Terms,  regular  in  both  cases. 
Pay  the  weekly  payroll  (checks  #21-25). 
January  15.     The  goods  ordered  from  the  Sample  Furniture  Co. 
arrive  (invoice  #2).     The  order  for  the  five  dining  room  sets  costing 
$200.00  could  not  be  filled  and  this  portion  of  the  order  is  canceled. 
The  delivery  of  the  30  fumed  oak  chairs  for  $300.00  is  delayed. 
Credit  the  Sample  Furniture  Co.  for  goods  delivered.     Arrange  for 
the  payment  of  this  account  as  follows:  cash,  $1,000.00  (check  #26), 
balance  note  without  interest  at  30  days. 
Receipts  on  account  as  follows: 

J.  H.  Brigham  $400.00 

H.  R.  Caldwell,  bill  of  Jan.  10  20.00 

J.  Collins,  bill  of  Jan.  11  (less  $.36  discount)  18.00 

Note: 

From  this  date  the  sales  are  listed  and  entered  at  the  end  of  each 
week  for  the  purpose  of  abbreviating  the  number  of  entries.  It 
must  not  be  forgotten  that  in  actual  business  sales  would  be  made 
and  entered  daily. 

The  freight  bill  for  the  first  two  weeks  in  January,  amounting  to 
$125.00,  is  presented  by  the  Valley  Central  Railroad.  Pay  by 
check  #27.  (Freight-in  is  part  of  the  cost  of  merchandise  pur- 
chased.) After  the  payment  is  receipted  and  entered,  an  error  of 
$10.00  is  discovered  in  the  bill  and  a  cash  refund  of  this  amount 
is  secured.  Receive  on  account  from  K.  C.  Riley,  $200.00. 
January  16.  The  following  bill,  dated  Jan.  10,  is  paid  with  check 
#28: 
To  A.  B.  Kirk,  Dr. 

Painting  of  sign  (advertising)  $10.00 

Painting  of  Store  7  5  •  00 

$85.00 


I04  ACCOUNTING  PRINCIPLES 

January  17.  Frank  Williams  draws  $25.00  as  an  advance  on  salary 
due  at  the  end  of  the  week.     (Check  #29.) 

January  18.     The  Clerk  discovers  that  the  $200.00  credited  to 
K.  C.  Riley  on  the  1 5th  should  have  been  credited  to  the  Rice  Mfg.  Co. 
Buy  an  Underwood  t)T>ewriter  from  the  Underwood  Company, 
price  $102.50. 

Buy  from  the  Comer  Book  Store  for  cash  (check  #30)  50  carbons 
for  $1.50  and  1000  letter  heads  for  $5.00. 
January  20.     Cash  sales  for  the  week  are  $870.00. 
Credit  sales  as  follows: 

#43,  Hotel  Bismarck  $150.00 

#44,  H.  P.  Square  Business  College  90.00 

#45,  Bagdad  University  325.00 

Terms:  net  30  days  in  each  case. 
#46,  J.  H.  Brigham  25.00 

Terms:  3%  10  days,  net  30  days. 
Pay  the  weekly  payroll,  checks  #31-35.     (Remember  the  advance 
payment  made  to  Frank  WiUiams.) 

The  chairs  on  the  Sample  Furniture  Co.  order  of  January  13th 
arrive  to-day.  invoice  #3.  Pay  by  check  #36.  (Enter  in  Purchase 
Journal  and  Cash  Journal.  Check  in  both  so  that  no  pwsting  will 
be  required.) 
Receive  from  H.  R.  Scott  check  for  bill  of  January  1 1 ,  less  discount. 
January  22.  Pay  the  Stechert  Advertising  Agency  for  four  ad- 
ditional half  page  insertions  in  the  Valley  News  according  to  the . 
agreement  of  January  12th.     (Check  #37.) 

J.  R.  James  is  dismissed  from  service.  Pay  him  $5.00  (check  #38) 
for  the  day's  service. 

Engaged  Floyd  Jones  as  clerk  at  $30.00  per  week  beginning  January 
24th. 

Pay  the  Rapid  Rep>air  Co.  $15.00  for  repairs  on  the  furniture 
bought  from  the  Sample  Furniture  Co.,  and  charge  the  amount  to 
the  Sample  Furniture  Co.  (check  #39). 

Pay  the  Rapid  Repair  Co.  $25.00  (check  #40)  for  repaurs  to  the 
store  fixtures. 
Receive  on  account  checks  as  follows: 

R.  H.  Thompson,  bill  of  Jan  12,  less  discount. 
R.  P.  Henderson,  bill  of  Jan.  12,  less  discoimt. 
(These  checks  are  accepted  since  they  were  mailed  within  the 
discount  period.) 
January  24.     Receive  payment  on  accoimt  as  follows: 

Bagdad  University  $180.00 

J.  Collins,  bill  of  Jan.  13,  less  discount. 

H.  R.  Caldwell,  bill  of  Jan.  13,  less  discount. 


TRANSACTIONS  OF   VALLEY  FURNITURE  STORE     105 

January  25.  In  counting  the  cash  for  the  day  there  was  found  an 
excess  of  $1.00  above  the  amount  shown  "^y  the  record  of  receipts 
and  sales. 

(It  is  usual  to  open  an  account  Over  and  Short  to  care  for  cash 
discrepancies.  Amounts  in  excess  of  the  recorded  receipts  are 
credited  to  this  account;  amounts  under  the  recorded  receipts  are 
debited  to  Over  and  Short.  At  the  end  of  the  month  the  account  is 
closed  into  Profit  and  Loss.) 

January.  26.     Frank  Williams  invests  $1000.00  in  the  business. 

January  27.  Frank  Williams'  personal  grocery  bill  of  $35.00  is 
paid  by  check  #41. 

Buy  the  lot  and  building  in  which  the  business  is  conducted  for 
$6000.00,  paying  $3000.00  in  cash  (land,  $2000.00,  building, 
$4000.00)  (check  #42),  and  making  a  five-year  8%  note,  payable  to 
R.  H.  Jones,  for  the  balance.  Interest  on  the  note  is  to  begin  on 
Feb.  I,  1914,  and  is  to  be  paid  semi-annually,  May  i  and  Nov.  i. 
A  cash  allowance  of  $10.00  is  received  for  rent  paid  this  month. 

January  27.     Cash  sales  for  the  week,  $483.00. 

Credit  Sales: 

#51,  Bagdad  University  $65.00 

#52,  J.  H.  Brigham  235.00 

#53,  H.  R.  Scott  428.00 

#54,  St.  Luke  Hospital  160.00 

#55)  J-  Collins  120.00 

Terms:  Regular  in  each  case,  except  the  Bagdad  University  bill  is 
30  days  net. 

Pay  the  weekly  payroll.     (Checks  #43-47.) 

(Floyd  Jones  is  paid  for  the  actual  time  employed.) 

January  30.  Buy  a  burglar-proof  safe  from  the  Lacy  Lock  &  Safe 
Co.  for  $150.00;  terms:  2%  10  days,  net  30  days. 


CHAPTER  Vm 
PETTY  CASH 

1.  Petty  Cash  Book.  —  The  cash  transactions  of  a  business 
are  more  readily  checked  if  all  money  received  is  deposited  in  a 
bank  and  all  money  expended  is  paid  out  by  check.  The  can- 
celed check  is  better  evidence  of  the  amount  paid  out  than 
even  a  signed  receipt,  the  check  automatically  becoming  a  re- 
ceipt through  the  endorsement  of  the  payee  when  the  cash  is 
secured. 

It  is  more  convenient,  however,  to  pay  small  amounts  for 
express,  telegrams,  and  other  sundry  expenses  over  the  counter 
in  cash.  As  these  small  amounts  are  expended,  a  receipt  for 
them  should  be  taken  and  deposited  in  the  cash  drawer  or  in  a 
lockable  money  box.  When  the  fund  set  aside  for  these  petty 
expenses  is  exhausted,  it  is  renewed,  the  process  being  repeated 
as  often  as  may  be  necessary.  If  the  fund  is  created  and  re- 
plenished by  check,  even  the  petty  expenses  of  the  business 
may  be  made  to  pass  through  the  bank. 

If  the  petty  expenditures  are  small  in  amount  and  volume, 
no  book  at  all  need  be  used  to  record  them.  The  receipts 
themselves  serve  as  evidence  of  payment  and  as  vouchers 
showing  what  accounts  should  be  charged.  If  the  payments 
are  frequent,  however,  and  large  in  the  aggregate,  they  should 
be  entered  in  a  special  book  known  as  the  Petty  Cash  Book. 

2.  Imprest  System  and  Associated  Journal  Entry.  —  In  the 
imprest  system,  this  book  is  used  simply  as  a  memorandum 
cash  journal  to  place  in  permanent  form  a  record  of  the  receipts 
and  disbursements  of  petty  cash.  The  creation  of  the  fund  is 
accomplished  by  the  following  journal  entry: 

Petty  Cash  loo.oo 

Cash  loo.oo 

Setting  aside  of  $100.00  for  petty  cash. 
106 


PETTY  CASH  107 

Let  us  assume  that  this  fund  is  replenished  on  the  first  of 
each  month,  and  that  the  expenditures  for  January  are  as  fol- 
lows: cartage,  $35.00;  postage,  $40.00;  general  expense, 
$20.00.  On  February  i,  a  check  would  be  drawn  to  cover 
these  items,  and  the  latter  entered  on  the  credit  side  of  the 
cash  journal.  From  the  cash  journal,  the  items  would  then  be 
posted  to  the  debit  side  of  the  proper  accounts.  After  the  first 
charge,  therefore,  there  is  no  debit  or  credit  to  petty  cash. 

When  petty  cash  is  handled  in  this  way,  the  clerk  in  charge 
should  at  all  times  have  in  his  fund  either  the  cash  charged  to 
him  or  the  receipts  which,  added  to  the  balance  on  hand  will 
equal  the  amount  originally  charged.  To  guard  against  possible 
shortages  the  fund  should  be  audited  at  least  once  each  month, 

3.  Petty  Cash  Journal.  —  The  petty  cash  book  is  sometimes 
used  as  a  book  of  original  entry,  thus  becoming  one  of  the 
journals  of  the  business.  This  method  involves  successive  deb- 
its and  credits  to  the  petty  cash  account.  The  account  is  charged 
on  the  cash  journal,  not  only  with  the  original  check  creating  the 
fund,  but  with  all  subsequent  checks  to  renew  it  when  depleted. 
The  expenditures,  on  the  other  hand,  are  charged  directly  from 
the  petty  cash  journal  to  the  proper  expense  accounts  and 
credited  to  petty  cash.  This  division  of  the  cash  record  into  two 
books  of  original  entry  might  result  in  serious  inconvenience, 
especially  when  the  keeper  of  the  petty  cash  is  not  located  in 
the  same  building  with  the  keeper  of  the  regular  cash  journal, 
and  accounts  for  the  common  use  of  the  imprest  system. 

The  form  of  the  petty  cash  book  or  journal  and  the  method 
of  entry  are  illustrated  on  pages  108-109. 

Transactions  for  Illustration  No.  13 

1  Received  check  No.  45  for  $100.00  to  be  used  for  petty  cash. 

2  Paid  on  a  collect  telegram  $1.25. 

3  Paid  out  for  postage  $5.00. 

4  Spent  for  sundry  office  supplies  $7.50. 

5  Paid  for  drayage  $2.50. 

6  Donated  to  charity  $5.00. 

7  Paid  for  carriage  hire  on  official  business  $1.50. 

8  Paid  out  for  express  charges  $1.35. 


io8 


ACCOUNTING  PRINCIPLES 


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no  ACCOUNTING   PRINCIPLES 

Under  the  imprest  system,  after  entering  the  transactions  in 
the  petty  cash  book,  as  shown,  the  petty  cash  clerk  forwards  to 
the  cashier  the  receipts  for  the  amounts  expended,  together 
with  a  memorandum  or  voucher  attached  giving  a  summary  of 
the  expenditures,  as  follows: 

Express  $1.35 

D ravage  2 . 50 

Office  Supplies  7 .  50 

General  Expense  12.75 

$24. 10 

Upon  receipt  of  the  charges,  the  cashier  enters  them  on  the 
credit  side  of  the  cash  journal,  and  sends  to  the  petty  cash 
clerk  a  check  for  the  full  amount.  WTien  entered  on  the  petty 
cash  book,  the  check  restores  the  petty  cash  to  its  original 
amount. 

If  the  petty  cash  book  were  used  as  a  journal,  the  items  of 
expense  would  be  brought  down  in  the  explanation  column  with 
the  amounts  in  the  paid  column  to  the  right.  The  charges 
would  then  be  posted  to  the  different  accounts,  and  the  ledger 
page  entered  in  the  folio  column,  as  in  the  case  of  other  journal 
postings.  The  folio  column  would,  of  course,  be  useless  if  the 
book  were  used  merely  as  a  memorandum  under  the  imprest 
system,  already  described. 

When  the  petty  cash  book  is  used  as  a  journal  the  original 
charge  to  petty  cash  appears  in  the  cash  journal.  If  the 
petty  cash  clerk  repo  ts  the  'oumal  entries  aris  ng  out  of  the 
petty  cash  journal  for  the  purpose  of  closing  or  furnishes  these 
journal  entries  to  the  keeper  of  the  general  ledger,  the  petty 
cash  account  in  the  general  ledger  would  be  credited  with  the 
total  of  the  amount  charged  to  the  several  expense  accounts. 
The  petty  cash  account  would  then  have  a  balance  differing 
from  the  original  charge  to  the  account.  In  any  case,  the 
credit  to  petty  cash  shou'd  be  posted  from  the  f>etty  cash  jour- 
nal at  the  same  time  the  several  expense  accounts  are  charged. 
When  the  cashier  issues  a  check  to  reimburse  the  petty  cash 
clerk  the  petty  cash  account  would  be  charged  again  in  the  gen- 
eral cash  journal  at  the  same  time  the  cash  account  is  credited 


PETTY  CASH  III 

for  the  amount  of  the  check  issued.  It  is  more  usual  and  also 
the  preferable  usage  to  make  the  petty  cash  book  a  memoran- 
dum book  and  the  only  charge  to  the  petty  cash  account  under 
such  usage  is  the  original  charge  made  when  the  fund  is  cre- 
ated. The  charges  to  the  expense  accounts  covered  by  the  ex- 
penditures of  the  petty  cash  clerk  are  then  entered  in  the  gen- 
eral cash  journal  at  the  same  time  that  the  check  is  issued  to 
reimburse  petty  cash.  That  is,  the  cash  account  is  credited  and 
the  expense  accounts  charged  so  that  the  petty  cash  account 
stands  as  it  was  at  the  beginning  of  the  fund. 

PROBLEMS  AND  QUESTIONS 

For  the  following  problems,  the  student  should  rule  a  letter  size  page  for 
petty  cash. 

1.  Enter  the  following  data  in  the  Petty  Cash  Book,  using  it  as  a  petty 
cash  memorandum  book.  Enter  the  expenditure  imder  the  following  ac- 
count headings:   express,  cartage,  delivery  expense,  general  expense. 

1919 

June  I  Received  from  the  cashier  $100.00  to  be  used  as  pettj^  cash,  the 
petty  cash  journal  to  be  turned  over  to  the  ledger  clerk  at 
regular  intervals  for  posting  to  the  ledger. 

2  Paid  for  repairs  to  oiSce  fixtures,  $2.50. 

3  Purchased  stamps  for  cash,  $5.00. 

4  Paid  charges  on  collect  telegram,  $1.25. 

5  Paid  for  drayage,  $3.50. 

6  Paid  for  express  charges,  $4.50. 

7  Paid  for  repairs  to  fixtures,   $5.00.     Settled  with  the  Valley 

Blacksmith  for   the   following:     Shoeing  of   horses,   S2.50; 
welding  of  tires,  $5.50;  other  repairs  to  wagon,  $4.75. 

8  Purchased  hay  for  delivery  team,  $5.00. 

9  Purchased  fuel  for  use  in  store,  $5.25. 

10  Make  up  a  statement  for  the  cashier,  covering  receipts  for  ex- 
penses to  date,  and  close  the  pett}^  cash  journal. 

12  The  cashier  reimburses  petty  cash  for  the  total  expenditures 
reported.  Journalize  the  items  showing  the  debits  and 
credits  for  items  going  into  the  regular  Cash  Journal. 

2.  Journalize  the  items  of  the  Pettj'  Cash  Book  as  of  June  12  as  they 
would  be  journalized  if  the  Patty  Cash  Book  were  used  as  a  jounidl.  In- 
dicate how  those  journal  entries  should  be  made  in  the  Petty  Cash  Journal. 


CHAPTER  rX 

APPORTIONMENT  OF  EXPENSES  TO  APPROPRIATE  PERIOD 
—  DEPRECIATION  AND  REPAIRS 

I.  Definition  of  Expense.  —  Expense  accounts  have  already 
been  referred  to  as  the  debit  balance  group  of  the  revenue  ac- 
counts. They  tend  to  decrease  proprietorship  or  capital,  while 
the  income  accounts,  the  other  group  of  revenue  accounts,  have 
precisely  the  opposite  effect. 

It  frequently  becomes  necessary  to  determine  whether  a  cer- 
tain outlay  is  an  asset  or  prof)erty  expenditure  or  an  expense. 
This  can  be  done  only  by  considering  it  in  connection  with  the 
particular  period  in  hand.  Thus,  if  $500.00  is  spent  for  fuel, 
the  purchaser  secures  an  asset  worth  $500.00.  If  the  fuel  so 
purchased  is  used  in  heating  the  store  building  for  the  month 
of  January,  a  summary-  of  the  expenses  for  that  month  must  in- 
clude the  $500.00.  If,  however,  only  one  fourth  of  the  fuel  is 
used  for  the  month  of  January',  then  only  $125.00  of  the  fuel 
outlay  can  be  regarded  as  expense  for  the  month  of  January, 
the  balance  constituting  an  asset  expenditure  at  the  close  of 
the  month. 

Expenditures  for  merchandise  are  treated  in  precisely  the 
same  way.  A  business  purchases,  we  will  say,  $10,000.00  worth 
of  goods  during  the  month  of  January'.  During  the  month, 
however,  only  half  of  the  goods  are  sold.  Consequently,  only 
$5,000.00  of  the  outlay  can  be  counted  as  an  exp)ense,  to  be 
charged  against  the  sales  in  the  calculation  of  the  profits  for 
the  month  of  January.  The  remaining  $5,000.00  worth  of  mer- 
chandise is  an  asset,  and  is  scheduled  as  such  in  the  balance 
sheet  at  the  close  of  the  month. 

If  the  question  is  asked,  therefore,  whether  a  certain  expen- 
diture is  an  asset  or  expense,  it  must  be  determined  whether 
the  outlay  is  a  part  of  the  cost  of  securing  the  income  for  the 


APPORTIONMENT  OF  EXPENSES  1 13 

definite  period  under  consideration.  If  entirely  used  up  in  se- 
curing this  income,  the  whole  outlay  becomes  an  expense.  If 
only  partly  used  up,  the  part  so  expended  becomes  an  expense, 
the  remainder  constituting  an  asset  at  the  close  of  the  period. 

2.  Supply  Inventories.  —  The  merchandise  on  hand  at  the 
close  of  a  period  has  been  scheduled  as  the  merchandise  inven- 
tory. Supplies  such  as  fuel,  stationery,  stamps,  etc.,  are  simply 
inventories  of  another  kind,  and  may  be  styled  supply  inven- 
tories. Just  as  credit  is  taken  in  the  merchandise  and  trading 
accounts  for  the  merchandise  on  hand  at  the  close  of  a  period, 
so  credit  must  be  taken  for  the  final  supply  inventories  in  clos- 
ing the  expense  accounts.  Thus,  if  the  $500.00  outlay  for  fuel 
referred  to  above  has  been  charged  to  expense,  credit  for  the 
$375.00  unexpended  on  January  31  must  be  taken  by  journal 
entry,  as  follows: 

Supply  Inventories  —  Fuel  3  7  5  ■  00 

Expense  375  00 

Credit  for  supply  inventories 

The  remainder  of  the  expense  account  is,  of  course,  a  pure 
expense,  and  is  closed  into  profit  and  loss  by  the  following 
journal  entry: 

Profit  and  Loss  —  Expense  125.00 

Expense  —  Profit  and  Loss  125.00 

Closing  of  Expense  into  Profit  and  Loss 

By  these  two  journal  entries,  therefore,  there  has  been  a  cor- 
rect apportionment  of  the  $500  fuel  outlay  between  assets  and 
expense  for  the  period  ending  January  31. 

Although  there  can  never  be  a  correct  statement  of  net  prof- 
its without  an  apportionment  of  expenditures  between  assets 
and  expense,  a  business  may  neglect  to  take  credit  for  supplies 
on  hand  if  the  total  supplies  purchased  have  been  practically 
used  up  for  the  period  under  consideration.  In  some  instances, 
the  total  supplies  on  hand  never  constitute  any  considerable 
item  at  any  time  throughout  the  period.  This  might  be  true  of 
stationery  and  stamps.  In  such  instances,  also,  a  business  may 
legitimately  fail  to  take  credit  for  a  small  unused  balance. 


114  ACCOUNTING  PRINCIPLES 

In  many  accounting  texts,  the  apportionment  between  assets 
and  expense  is  referred  to  as  an  apportionment  between  capital 
expenditures  and  expense.  It  is  fair,  however,  to  question  the 
appropriateness  of  this  terminology,  since  an  asset  expenditure 
may  leave  capital  unaffected,  whereas  an  expense  outlay  always 
tends  to  decrease  capital.  True,  the  word  capital  is  frequently 
used  in  economics  as  sj-nonymous  with  assets,  but  in  accounting 
there  should  be  a  consistent  use  of  terms  and  a  precise  definition 
of  them.  In  the  interest  of  clearness,  therefore,  business  outlays 
should  be  referred  to  as  asset  expenditures  or  as  expense. 

3.  Definition  of  Depreciation.  —  Certain  assets,  frequently 
called  fixed  assets,  such  as  houses,  land,  office  equipment,  fac- 
tory machinery,  etc.,  are  secured  to  furnish  the  necessary  fa- 
cilities for  the  conduct  of  the  business.  One  is  accustomed  to 
think  of  these  as  durable  assets  —  as  assets  not  used  up  in  the 
ordinary  conduct  of  the  business  —  and  to  think  of  expendi- 
tures for  them  as  asset  expenditures. 

While  these  particular  assets  are  not  used  up  so  rapidly  as 
supplies,  still  they  are  used  up  over  a  longer  or  shorter  period 
of  time,  thus  becoming  an  expense  of  operation  for  the  period 
over  which  they  are  used.  Thus,  if  a  t>'pewriter  costing  Sioo.oo 
lasts  ten  years,  the  Sioo.oo  outlay  becomes  a  charge  to  expense. 
If  the  business  is  calculating  profits  for  a  one-year  p>eriod  only, 
manifestly  only  one  tenth  of  the  amount,  or  Sio.oo,  should  be 
charged  to  this  account;  for,  if  the  loss  of  the  asset,  which  is 
equal  to  the  cost  of  the  asset,  were  charged  entirely  to  any  one 
year,  the  other  nine  years  would  fail  to  bear  their  proportion- 
ate cost  of  the  profit  arising  from  the  use  of  the  tN^je writer  in 
question.  The  cost  of  the  typewriter  should,  consequently,  be 
equitably  distributed  over  the  ten-year  period  in  charging  the 
loss  of  the  asset  to  expense.  This  process  of  charging  a  fixed 
asset  to  expense  over  the  period  of  the  life  of  the  asset  is  called 
depreciating  the  asset,  or  the  depreciation  of  the  asset. 

4.  Causes  of  Depreciation.  —  The  causes  of  depreciation  of 
a  fixed  asset  are  as  numerous  as  the  factors  affecting  the  life  of 
the  asset  itself.  The  causes  generally  considered  are  wear  and 
tear,  obsolescence,  inadequacy,  and  accident. 


APPORTIONMENT  OF  EXPENSES  115 

If  the  type  of  machinery  and  tools  used  in  a  factory  did  not 
change  from  year  to  year,  the  life  of  these  assets  would  be 
marked  by  the  period  of  their  usefulness  as  determined  by  or- 
dinary wear  and  tear.  This  period  of  usefulness  is  frequently 
shortened,  however,  by  the  appearance  of  improved  machines 
and  tools.  If  such  later  types  reduce  the  expense  of  produc- 
tion by  an  amount  in  excess  of  an  adequate  return  on  the  in- 
vestment involved  in  their  purchase  and  installation,  the  earlier 
types  are  discarded  as  obsolete. 

A  tool  or  machine  may  also  become  worthless  for  purposes  of 
operation  because  of  inadequacy  long  before  its  usefulness  is  de- 
stroyed through  wear  and  tear.  Thus,  a  certain  switchboard 
may  provide  satisfactorily  for  all  of  the  telephones  that  can  be 
attached,  but  the  growth  of  the  community  may  have  been 
such  that  the  old  switchboard  must  be  discarded  for  a  new  one 
equipped  for  a  larger  service.  In  other  words,  the  old  switch- 
board has  become  inadequate,  and  its  life  has  been  shortened 
materially  by  reason  of  this  inadequacy. 

The  life  of  an  asset  is  also  frequently  shortened  by  fire  or 
flood,  or  by  some  other  accidental,  providential,  or  fortuitous 
circumstance.  There  are  doubtless  other  possible  causes,  but 
those  mentioned  will  suffice  to  show  the  nature  of  depreciation. 

5.  Depreciation  and  Price  Reductions.  —  Frequently  the 
value  of  an  asset  is  reduced  through  a  lowering  of  the  cost 
price.  For  instance,  after  a  machine  has  been  in  operation  for 
a  year,  the  price  of  the  machine  may  be  so  reduced  that  a  new 
one  could  be  installed  for  half  the  original  cost.  The  question 
therefore  arises  as  to  whether  there  should  be  set  up  a  deprecia- 
tion charge  of  half  the  cost  of  the  old  machine.  If  the  defini- 
tion already  given  of  depreciation  is  the  correct  one,  it  is  clear 
that  there  has  been  no  depreciation.  The  old  cost  must  be 
properly  distributed  over  the  useful  life  of  the  asset,  regardless 
of  what  the  cost  of  the  new  asset  may  be.  In  other  words,  the 
amount  of  expense  that  is  to  be  occasioned  by  the  purchase  of 
an  asset  is  determined  at  the  time  of  the  purchase.  A  lower 
price  at  a  later  date  has  nothing  to  do  with  the  original  expense 
or  with  its  proper  distribution.    The  reduction  in  the  price  of 


Il6  ACCOUNTING  PRINCIPLES 

assets  is  a  question  to  be  considered  in  connection  with  the 
valuation  of  assets,  to  be  treated  in  a  subsequent  chapter. 

6.  Methods  of  Charging  Depreciation.  —  An  asset  may  be 
entirely  worthless  at  the  expiration  of  its  useful  life  in  a  busi- 
ness, or  it  may  have  a  value  as  scrap.  The  scrap  value  of  an 
asset  is  its  value  for  purposes  other  than  those  of  the  business 
by  which  it  is  owned,  or  its  value  on  the  market  apart  from  the 
going  concern  for  which  it  was  purchased.  As  this  scrap  value 
cannot  be  definitely  fixed  until  the  asset  is  sold,  the  depre- 
ciated asset  is  carried  on  the  books  of  the  concern  at  an  esti- 
mated market  price.  The  original  cost  of  the  asset  less  the 
scrap  value  may  be  designated  as  the  use  value  of  the  asset. 
There  are  several  well-known  methods  of  charging  this  use 
value  to  exjDense.  Chief  among  these  are  the  straight-line 
charge,  the  charge  of  a  constant  per  cent  of  the  diminishing 
value,  and  the  sinking-fund  method. 

7.  Straight-line  Depreciation.  —  This  method  involves  a 
charge  for  depreciation  each  time  the  books  are  closed  in  con- 
nection with  the  calculation  of  profits.  As  the  books  are  usually 
closed  at  regular  intervals  —  monthly,  quarterly,  semiannu- 
ally, or  annually  —  the  use  value  of  the  asset  is  divided  by  the 
number  of  such  periods  which  mark  its  useful  life,  the  quotient 
representing  the  amount  to  be  charged  as  depreciation  at  the 
close  of  each  succeeding  period.  Thus,  if  the  use  value  of  a 
machine  is  $400.00  and  the  period  of  useful  service  is  ten  years, 
an  annual  depreciation  charge  of  $40.00  must  be  made  at  each 
successive  yearly  closing.  This  is  the  method  most  commonly 
used. 

8.  Constant  Percentage  of  Diminishing  Value.  —  The  straight- 
line  method  is  sometimes  criticized  because  it  does  not  accom- 
plish what  at  first  thought  it  seems  to  accomplish.  It  seems  to 
distribute  the  cost  of  the  asset  equally  over  the  periods  of  its 
use.  This  purpose,  however,  is  defeated  by  reason  of  the  fact 
that  repairs  to  the  asset  cost  more  each  year  as  the  end  of  its 
useful  life  is  approached.  In  other  words,  this  constant  increase 
in  the  cost  of  repairs  results  in  a  gradually  increasing  charge 
in  connection  with  the  service  furnished  by  a  given  asset. 


Depreciation 

Residual  Value 

$100.00 

$400 . 00 

80.00 

320.00 

64.00 

256.00 

51.20 

204 .  80 

40.96 

163.84 

32.76 

131.08 

APPORTIONMENT  OF  EXPENSES  117 

To  meet  this  defect,  it  has  been  suggested  that  a  charge  of  a 
certain  constant  percentage  of  the  diminishing  value  of  the  as- 
set should  be  made  at  the  close  of  each  period  until  the  entire 
use  value  of  the  asset  has  been  charged  off  for  depreciation. 
For  example,  if  a  machine  costing  $500.00  has  a  residual  or 
scrap  value  at  the  end  of  six  years  of  $131.08,  an  annual  depre- 
ciation charge  of  20%  of  the  diminishing  value  of  the  machine 
is  made.    The  yearly  charges  are  as  follows: 

Value 
$500.00 
400 . 00 
320.00 
256.00 
204 . 80 
163.84 

This  method  of  depreciation  accomplishes  the  desired  pur- 
pose only  when  the  annual  increase  in  the  cost  of  repairs  is 
equal  to  the  annual  decrease  in  the  depreciation  charge. 
It  is  not  to  be  expected,  of  course,  that  there  will  be  an 
exact  equality;  but,  unless  the  two  quantities  are  approxi- 
mately equal,  this  method  is  not  far  superior  to  straight-line 
depreciation. 

The  percentage  of  diminishing  value  to  be  applied  in  the 
method  under  consideration  may  be  derived  as  follows: 

Let  V  =  the  original  cost  of  the  asset 
R  =  the  residual  value 
d    =  the  rate  of  depreciation  which  will  reduce  V  to  Rin  n 

years 
n   =  the  number  of  years  of  useful  life  of  the  asset 
Then  V—dV  =  residual  value  at  the  end  of  the  first  year 

V  —dV—d{V  —dV)=  residual  value  at  the  end  of  the  second 

year 
V(i  —d)^=  residual  value  at  the  end  of  the  second  year 
V(i  —J)"  =  residual  value  at  the  end  of  the  «th  year 
7(i  -d)"  =  R 

(i  -d)»  =  R/V 

I  -d    =  Wr/v 

d    =  I  -  Wr^V- 


Il8  ACCOUNTING  PRINCIPLES 

Thus  the  rate  of  depreciation  to  be  applied  to  the  residual 
value  of  an  asset  each  year  to  charge  off  the  use  value  of  the 
asset  in  n  years  is  one  minus  the  «th  root  of  the  final  residual 
or  scrap  value  divided  by  the  original  value  or  cost.  This 
equation  is  easily  solved  in  a  given  case  by  the  use  of  logarithms. 
Substituting  in  this  equation  the  figures  from  the  example  given 
above,  we  have 


J  =  I  —  V  131.08/500.00  =  20% 

9.  Repairs  and  Depreciation.  —  Depreciation  is  sometimes 
defined  as  the  wear  that  cannot  be  repaired.  Regular  and 
skillful  repairs  frequently  lengthen  the  period  of  usefulness  of 
an  asset,  and  the  failure  to  make  such  repairs  often  results  in  a 
more  rapid  depreciation  of  the  asset.  This  close  relation  be- 
tween depreciation  and  repairs  suggests  the  possibility  of  charg- 
ing each  year  for  depreciation  and  repairs  an  amount  sufficient 
to  provide  for  both  these  items.  The  balance  not  spent  for  re- 
pairs may  then  be  charged  to  depreciation.  This  method  of 
providing  for  depreciation  can  be  used  to  make  constant  dur- 
ing the  life  of  the  asset  the  cost  of  the  services  rendered  by  it, 
without  at  the  same  time  obscuring  the  actual  expenditures  for 
repairs. 

Let  us  suppose  that  the  residual  or  scrap  value  of  a  machine 
costing  $600.00  is  $100.00  at  the  end  of  five  years,  and  that  a 
fair  estimate  of  the  average  annual  cost  of  repairing  the  ma- 
chine is  $30.00.  Then  the  total  cost  of  securing  efficient  service 
from  the  machine  for  the  five-year  period  is  $650.00,  or  an  aver- 
age cost  of  $130.00  a  year.  During  the  first  year,  the  repair 
bill  would  of  course  be  small,  possibly  not  more  than  $20.00, 
while  the  charge  for  depreciation  would  be  relatively  large,  or 
$110.00.  During  the  fourth  year,  the  repair  bill  would  prob- 
ably be  about  $40.00,  whereas  the  depreciation  charge  would 
be  reduced  to  $90.00  Thus  the  total  annual  charge  for  both 
depreciation  and  repairs  remains  unchanged. 

10.  Depreciation  Reserve  —  The  first  method  of  journaliz- 
ing depreciation  that  suggests  itself  is  to  debit  depreciation  and 
to  credit  the  account  of  the  depreciating  asset.    Thus,  if  delivery 


APPORTIONMENT  OF  EXPENSES  1 19 

equipment  were  the  asset  in  question,  and  the  amount  of  the 
depreciation  charge  were  $40.00,  the  journal  entry  would  be: 

Depreciation  40 .  00 

Delivery  Equipment  40.00 

Record  of  depreciation  of  delivery  equipment 

The  chief  objection  to  this  method  of  entering  the  deprecia- 
tion charge  is  that  it  destroys  the  record  of  the  original  cost  of 
the  asset  as  contained  in  the  asset  account.  In  practice,  there- 
fore, the  charge  is  credited  to  an  entirely  new  account,  known 
as  the  depreciation  reserve,  which  must  be  considered  in  con- 
nection with  the  asset  account  to  obtain  the  correct  current 
value  of  the  asset.  For  this  reason,  the  depreciation  reserve  is 
commonly  called  an  offset  or  valuation  account,  its  balance  in- 
dicating the  amount  by  which  the  current  book  value  of  the 
corresponding  asset  is  overstated.  The  effect  of  the  deprecia- 
tion reserve  is  simply  to  hold  the  offset  in  suspense  until  the 
preparation  of  the  balance  sheet,  when  the  current  value  of 
the  asset  is  shown  as  the  difference  between  the  original  cost 
and  the  depreciation  reserve. 

The  better  method  of  journalizing  the  depreciation  of  the  de- 
livery equipment,  therefore,  is  to  debit  depreciation  and  to  credit 
the  depreciation  reserve  of  the  particular  asset,  as  follows: 

Depreciation  40. 00 

Depreciation  Reserve  for  De- 
livery Equipment  40.00 
Record  of  depreciation  of  delivery  equipment 

If  the  original  cost  of  the  equipment  was  $250,00,  the  current 
value  of  the  asset  is  entered  in  the  balance  sheet  in  the  follow- 
ing manner: 

JOHN  SMITH 

Balance  Sheet,  December  31,  1918 

Assets  Liabilities 

Sundry  Assets  $7250.00      Sundrj'^  Liabilities         $460.00 

Delivery  Equip-  John  Smith,  Capital     7000 .  00 

ment  $250.00 

Less  Depreci- 
ation Reserve  40 .  00      2 1  o .  00 

$7460.00  $7460.00 


I20  ACCOUNTING  PRINCIPLES 

This  method  of  handling  the  depreciation  charge  is  applicable 
to  straight-line  depreciation  as  well  as  to  the  fixed  percentage 
of  diminishing  value. 

If  depreciation  and  repairs  are  provided  for  in  one  reserve 
and  by  the  same  estimated  charge,  the  charge  is  journalized  as 
follows: 

Depreciation  i  lo .  oo 

Depreciation  Reserve  iio.cx> 

Charge  of  depreciation  and  re- 
pairs for  one  year 

At  the  time  this  entry  is  made,  there  would  aheady  exist  on 
the  books  the  cost  of  repairs  for  the  period  under  consideration. 
If  these  repairs  amount  to  $40.00,  they  would  be  closed  out  by 
the  following  journal  entry: 

Depreciation  Reserve  40.00 

Repairs  40.00 

Closing  of  repairs  into  depreci- 
ation reserve 

After  this  journal  entry  is  posted,  the  balance  of  the  depre- 
ciation reserve  represents  the  total  depreciation  charge  against 
the  cost  value  of  the  asset  in  question. 

If  it  is  considered  desirable  for  the  profit  and  loss  account  to 
show  separately  the  charges  for  repairs  and  for  depreciation, 
this  result  can  be  accomplished  by  closing  the  original  repairs 
account  into  profit  and  loss  and  at  the  same  time  making  a 
corresponding  offset  to  the  depreciation  reserve  and  the  depre- 
ciation charge,  as  follows: 

Profit  and  Loss  —  Repairs  40 .  00 

Repairs  —  Profit  and  Loss  40 .  00 

Closing  of  repairs  into  profit 
and  loss 

Depreciation  Reserve  40.00 

Depreciation  40 .  00 

Allowance  for  repairs  in  the  de- 
preciation charge  and  de- 
preciation reserve 


APPORTIONMENT  OF  EXPENSES  121 

After  the  depreciation  account  is  closed  into  profit  and  loss, 
the  latter  account  would  show  separate  entries  for  depreciation 
and  for  repairs.  Obviously,  these  separate  items  might  be  com- 
bined into  a  single  item,  the  separate  entries  becoming  merely 
memorandum  side  entries,  as  follows: 

Depreciation  and  Repairs  iio.oo 

Depreciation  70 .  00 

Repairs  40.00 

This  method  of  providing  for  both  depreciation  and  repairs 
through  a  reserve  is  not  commonly  recommended  in  accounting 
texts,  nor  will  it  be  found  to  be  the  common  practice.  It  pro- 
vides, however,  a  most  satisfactory  means  of  showing  that  de- 
preciation is  ordinarily  greatest  when  repairs  are  lowest,  and 
an  unfailing  method  of  equitably  distributing  the  charge  for 
the  depreciation  and  maintenance  of  an  asset  over  the  period 
of  its  usefulness. 

II.  Sinking-fund  Method  of  Depreciation.  —  It  is  question- 
able whether  there  is  any  method  of  depreciation  that  can 
properly  be  styled  the  sinking-fund  method.  A  sinking-fund  is 
usually  set  aside  for  purposes  of  replacement.  The  ordinary 
depreciation  charge  and  the  creation  of  a  depreciation  reserve 
result  in  a  lessening,  by  the  amount  of  the  charge,  of  the  prof- 
its to  be  added  to  capital  or  to  be  withdrawn  from  the  business, 
the  funds  thus  reserved  from  distribution  being  commonly  used 
for  the  general  purposes  of  the  business  rather  than  set  aside  as 
a  special  fund  for  the  replacement  of  the  depreciating  assets. 
If  the  depreciation  charge  is  to  be  set  aside  and  allowed  to  ac- 
cumulate, then  the  problem  arises  as  to  how  much  must  be  set 
aside  each  year  and  placed  at  compound  interest  in  order  to 
equal  the  original  cost  of  the  asset  by  the  time  its  useful  life  is 
ended.  As  the  interest  on  the  fund  is  a  part  of  the  depreciation 
charge,  the  actual  charge  is  composed  of  the  annual  install- 
ment plus  the  interest  for  the  year  on  the  amounts  set  aside  in 
the  past.  Thus,  if  the  charge  for  the  year  is  $250.00  and  the 
interest  on  the  funds  already  set  aside  is  $50.00,  these  items  are 
placed  on  the  books  by  the  following  journal  entry: 


122  ACCOUNTING  PRINCIPLES 

Depreciation  300 .  00 

Depreciation  Reserve  300.00 

Charge  of  depreciation  for  the  year 

The  following  additional  entries  must  be  made  in  connection 
with  the  fund  itself: 

Depreciation  Fund  Cash  250.00 

Cash  250 . 00 

Setting  aside  of  annual  install- 
ment to  depreciation  fund 

Depreciation  Fimd  Cash  50.00 

Interest  50.00 

Credit  to  interest  of  income 
from  depreciation  fund 

Instead  of  being  charged  directly  to  the  depreciation  fund, 
the  interest  might  be  charged  first  to  cash,  and  then  credited  to 
cash  and  charged  to  the  depreciation  fund.  It  is  simpler,  how- 
ever, to  treat  the  depreciation  fund  cash  as  a  separate  ac- 
count and  charge  the  interest  directly  to  this  account. 

The  discussion  of  a  depreciation  fund  belongs  to  the  chapter 
on  funds  and  is  inserted  here  to  avoid  an}'  confusion  that 
might  result  from  the  use  of  the  phrase  sinking-Jund  method  of 
depreciation.  The  purpose  is  to  call  attention  to  the  fact  that 
a  special  fund  for  depreciation  is  sometimes  created  in  place  of 
a  depreciation  reser\'e  from  profits  to  be  used  for  the  general 
purposes  of  the  business. 

12.  Scrapping  an  Asset  —  A  depreciation  reserve  being  set 
up  to  show  the  extent  to  which  the  value  of  an  asset  is  over- 
stated on  the  books,  the  asset  is  kept  on  the  books  at  its  orig- 
inal value  until  its  useful  life  is  over.  When  it  wears  out  or  is 
discarded  for  any  reason,  the  asset  account  is  credited  for  the 
original  cost  of  the  asset,  and  the  depreciation  reserve  and  the 
scrap  account  are  charged,  resp)ectivel\-,  with  the  use  value  and 
scrap  value.  Since  the  purpose  of  the  depreciation  reserve  is 
to  denote  an  excessive  book  value,  it  follows  that  the  depre- 
ciation reserve  should  be  marked  out  at  the  same  time  this  ex- 
cessive value  is  marked  off. 


APPORTIONMENT  OF  EXPENSES  123 

Let  us  suppose  that  a  machine  costing  originally  $600.00  is 
worth  only  $100.00  as  scrap  at  the  end  of  its  useful  life.  Mani- 
festly, scrap  should  be  charged  for  $100.00  and  the  deprecia- 
tion reserve  for  $500.00,  and  the  asset  account  credited  for 
$600.00.  In  the  journal,  these  operations  would  be  entered  as 
follows: 

Depreciation  Reserve  for  Ma- 
chinery 500 .  00 

Scrap  100.00 

Machinery  600 .  00 

Marking  off  the  use-value  of 
discarded  machinery 

If  a  new  machine  were  now  purchased  for  $750.00  from  the 
Central  Electric  Company,  the  transaction  would  be  recorded 
by  the  following  journal  entry: 

Machinery  7  50 .  00 

Central  Electric  Company  750.00 

Purchase  of  machinery 

The  fact  that  the  machine  is  a  replacement  does  not  make 
the  entry  of  its  purchase  differ  from  that  of  the  ordinary  pur- 
chase of  machinery. 

When  no  depreciation  account  is  kept,  a  business  frequently 
charges  replacements  to  expense,  just  as  it  does  outlays  for  re- 
pairs. While  it  is  bad  practice  to  neglect  to  keep  a  deprecia- 
tion account,  it  is  not  bad  practice  to  charge  replacements  to 
expense  in  amounts  equal  to  the  cost  of  the  machines  replaced 
when  no  depreciation  account  is  kept. 

13.  Extraordinary  Repairs.  —  The  question  may  be  fairly 
raised  as  to  whether  expenditures  for  repairs  are  an  expense, 
since  they  do  not  entirely  disappear  in  connection  with  the  sale 
of  merchandise.  In  fact,  if  all  the  depreciation  in  assets  were 
charged  off  as  expense,  it  would  not  necessarily  be  erroneous  to 
charge  repair  expenditures  to  the  corresponding  assets.  These 
small  expenditures  from  year  to  year,  however,  amount  to  a 
smaller  sum  than  the  depreciation  on  the  property,  and 
charging    them    to    expense    merely    decreases    the    amount 


124  ACCOUNTING  PRINCIPLES 

to  be  charged  to  depreciation.  The  total  value  of  the 
property  is,  therefore,  still  less  than  it  was  when  the  asset 
was  new. 

If  the  repair  items  were  large  in  some  years,  however,  and 
small  in  others,  there  would  be  an  unfair  distribution  of  the 
expense  of  maintenance.  This  imfaimess  would  be  especially 
evident  if  some  unusually  large  expenditure  were  required  in 
any  one  year.  For  instance,  in  a  boiler  room  the  boilers  need 
to  be  relined  about  once  ever\'  five  years.  Since  the  expense  of 
reliiiing  would  be  a  large  percentage  of  the  total  boiler-room 
exp>ense,  the  cost  of  operations  would  be  imfairly  stated  for  the 
year  to  which  such  repairs  are  charged.  This  would,  of  course, 
not  be  the  case  if  depreciation  and  repairs  were  provided  for  in 
one  reserve,  as  indicated  above.  But,  if  only  the  depreciation 
not  made  good  by  repairs  is  provided  for  in  the  depreciation 
charge,  then  it  becomes  necessary  to  devote  special  attention  to 
extraordinary  expenditures  for  repairs,  and  to  distribute  them 
over  several  years,  in  order  that  the  profits  of  a  particular  year 
may  not  be  unreasonably  small.  In  other  words,  the  amount 
of  the  expenditure  not  charged  to  expense  must  be  carried  as 
an  asset  in  what  is  known  as  a  deferred  expense  account,  an 
asset  of  this  character  being  scheduled  as  a  deferred  expense. 
The  account  should  contain  a  complete  explanation  of  each 
item  closed  into  it. 

To  illustrate,  suppose  that  the  extraordinar\'  repair  account 
debit  balance  is  $800.00,  and  that  it  is  desired  to  defer  $600.00 
of  this  amount.    The  journal  entry  would  then  be: 

Deferred  Expense  —  Extraordinarj'  Repairs      600.00 

Extraordinar>"  Repairs — Deferred  Expense  600 .  00 

Charge  of  $600.00  of  extraordinary  repairs 
to  deferred  expense 

The  remaining  $200.00  of  the  extraordinar>'  repairs  account 
would,  of  course,  be  closed  into  profit  and  loss  by  the  usual 
closing  entry. 

As  the  deferred  expense  account  is  opened  only  for  the  pur- 
pose of  closing  the  books,  the  deferred  expense  charge  is  re- 


AI>t>ORtIONMENT  OF  EXPENSES  125 

Versed  when  the  books  are  opened  again  for  the  entry  of  the 
transactions  of  a  subsequent  period;  thus: 

Extraordinary  Repairs  —  Deferred  Expense      600 .  cx> 

Deferred  Expense  —  Extraordinary  Repairs  600 .  00 

Reversal  of  deferred  expense  entry  made  in 
closing 

By  means  of  these  entries,  $200.00  of  the  extraordinary  re- 
pairs account  has  been  charged  to  expense  for  the  period  af- 
fected by  the  closing.  The  remaining  $600.00  has  been  deferred 
for  the  purpose  of  distributing  it  over  the  succeeding  years  at 
the  rate  of  $200.00  a  year. 

The  reversing  entry  item  may,  however,  be  avoided  by  re- 
garding the  account  of  extraordinary  repairs  as  an  asset  account 
instead  of  an  expense  item,  but  as  an  asset  the  cost  of  which 
accrues  as  expense  from  year  to  year  just  as  the  cost  of  a  ma- 
chine gradually  becomes  expense  through  the  depreciation 
charge  as  the  machine  wears  out.  If  the  $200.00  referred  to 
above  were  regarded  as  the  part  of  extraordinary  repairs  which, 
at  the  end  of  the  year,  had  become  expense,  this  could  be  indi- 
cated by  the  following  journal  entry: 

Repairs  200 .  00 

Extraordinary  Repairs  200 .  00 

Crediting  the  extraordinary  repairs  account 

with  the  amount  chargeable  to  repairs 

for  the  period 

The  balance  of  the  extraordinary  repairs  account  could  then 
be  carried  down  to  the  balance  sheet  and  grouped  with  other 
similar  items  under  the  caption  of  deferred  expense,  but  no  re- 
versing entry  would  be  required.  The  same  entry  could  be 
made  at  the  end  of  successive  periods  until  the  whole  of  the  orig- 
inal $800.00  of  extraordinary  repairs  had  been  charged  to  ex- 
pense. 

There  are  various  other  deferred  expense  items,  such  as  in- 
surance paid  in  advance,  rent  paid  in  advance,  etc.  All  these 
items  in  closing  follow  the  same  treatment  as  expenditures  for 
extraordinary  repairs. 


126  ACCOUNTING  PRINCIPLES 

14.  Other  Adjustment  Items.  —  There  are  other  adjustment 
items  at  closmg  that  ordinarily  require  attention.  These  are 
postponed  to  a  later  chapter. 

15.  Replacing  Parts  of  an  Asset.  —  Let  us  suppose  that  all 
the  machinery  of  a  boiler  and  engine  room  be  considered  as  a 
unit  in  determining  the  depreciation  charge  and  the  credits  to 
the  depreciation  reserve.  The  boiler  in  such  a  group  of  ma- 
chinery may  wear  out  at  the  end  of  five  years  and  the  engine 
at  the  end  of  ten  years.  The  prevailing  practice  would  require 
that  the  cost  of  the  boiler  be  charged  to  the  depreciation  re- 
serve and  credited  to  the  machinery  account  at  the  time  it 
might  be  scrapped.  The  cost  of  the  new  boiler  would  also  be 
charged  to  the  machinery  account  and  credited  to  the  seller  or 
cash  according  to  the  manner  of  purchase.  Under  such  a  pro- 
gram of  purchasing  separate  units  of  machinery  it  is  clear  that 
at  no  time  after  the  initial  installation  would  the  machinery  all 
be  new  at  the  same  time.  It  is  also  clear  that  there  would 
constantly  be  to  the  credit  of  the  depreciation  reserve  the  esti- 
mated amount  of  depreciation,  which  had  accrued  on  such  ma- 
chines as  had  been  used  for  a  period  but  had  not  worn  out. 
This  balance  serves  for  valuation  purposes  to  indicate  the  ex- 
tent to  which  the  cost  of  all  these  old  machines  exceeds  what 
may  be  regarded  as  their  fair  going  value. 

A  little  consideration  will  also  show  that  if  an  amount  of 
cash  were  always  set  aside  in  a  special  fund  equal  to  the  charge 
for  depreciation,  there  would  always  be  an  amount  of  cash  on 
hand  in  this  fund  approximately  equal  to  the  credit  balance  of 
the  depreciation  reserve.  If  the  depreciation  estimate  had 
been  correct  there  would  always  be  a  large  balance  in  the  de- 
preciation fund  not  required  for  replacement  purposes  unless 
all  of  the  machinery  should  wear  out  at  the  same  time. 

In  some  instances  one  plant  item,  in  its  relation  to  deprecia- 
tion, is  like  the  boiler  and  engine  group  of  machines.  A  dis- 
tinct part  of  the  item  may  be  replaced  without  replacing  the 
item  as  a  whole.  Railroad  tracks  are  an  illustration  in  point. 
If  sixty  feet  of  the  track  became  worn  while  the  rest  were  in 
good  repair  a  special  section  might  be  replaced.     Would  the 


APPORTIONMENT  OF  EXPENSES  127 

cost  of  the  special  section  be  charged  to  a  repair  account  under 
the  heading  maintenance  of  way  or  would  it  be  charged  to  the 
depreciation  reserve  for  railroad  tracks?  Since  the  practice 
would  sanction  a  charge  to  maintenance  of  way  the  question 
arises  as  to  the  value  of  the  reserve  for  depreciation  since  no 
charge  would  be  made  against  it.  If  such  a  reserve  were  cre- 
ated it  is  clear  that  there  would  be  soon  accumulated  an 
amount  which  would  be  sufficient  to  indicate  the  prevailing 
diflEerence  between  the  value  of  the  railroad  track  after  years  of 
use  as  compared  with  the  initial  cost.  Where  such  a  situation 
should  obtain  there  would  cease  to  be  any  occasion  for  further 
charges  to  depreciation  of  track  or  of  credits  to  the  correspond- 
ing depreciation  reserve.  On  the  other  hand,  there  is  always 
the  possibility  of  making  the  charge  for  depreciation  large 
enough  to  cover  all  repairs  and  partial  replacements.  This  pol- 
icy would  require  that  the  cost  of  the  repairs  and  replacements 
be  charged  against  the  depreciation  reserve  at  the  time  of  clos- 
ing the  books.  In  planning  a  system  of  accounts  for  any  busi- 
ness there  should  be  a  consistent  policy  adopted  in  regard  to 
repairs  and  depreciation  so  that  the  balance  of  the  deprecia- 
tion reserve  may  be  relied  upon  as  a  reasonable  statement  of 
the  amount  of  depreciation  which  has  accrued  on  the  assets 
still  in  use.  If  an  item  is  not  replaced  in  total  at  any  time  and 
its  partial  replacement  from  time  to  time  is  charged  to  repairs 
or  maintenance,  the  question  frequently  arises  as  to  whether  it 
is  worth  while  to  make  any  depreciation  charge  against  such 
an  item,  particularly  if  its  condition  is  kept  as  good  as  new.  If, 
in  fact,  the  asset  were  kept  as  good  as  new,  no  depreciation 
would  be  necessary.  If,  on  the  other  hand,  it  were  maintained 
indefinitely  by  expense  charged  to  repairs  or  maintenance,  but 
at  the  same  time  after  five  years  or  more  of  use  were  worth 
only  three  fourths  of  the  original  value  (assuming  a  stable  price 
situation)  then  it  would  seem  to  be  fair  to  spread  the  deprecia- 
tion charge  of  one  fourth  the  original  cost  over  the  years  re- 
quired for  the  depreciation  in  question  to  accrue. 


128  ACCOUNTING  PRINCIPLES 


PROBLEMS  AND   QUESTIONS 

1.  Directions  for  the  January  closing: 

(a)    Close  the  cash  account  with  red  ink  dosing  and  bring  down  the 
balance. 

(i)    Take  a  trial  balance. 

(c)    Before  closing  any  account  into  pro6t  and  loss,  make  journal 
entries  and  post  to  show  the  following  items: 
(i)   A  depreciation  resen-e  of  2%  on  deliver)'  equipment, 
1%  on  furniture  and  fixtures  and  J^  of  1%  on  building. 

(2)  The  loss    through   depreciation  of   a  deUver>-  wagon 

costing  originally  $200.00  and  having  a  scrap  value 
of  $25.00. 

(3)  A  fuel  inventory  of  one  ton  of  coal  costing  $7.00. 

(4)  A  stationery  inventory  of  half  the  amount  purchased 

during  the  month. 

(5)  A  deferred  charge  of  half  the  advertising  expenditures 

for  the  month. 
{d)   Close  through  the  journal  all  accounts  which  are  closed  into 
the  trading  account,  and  enter  the  merchandise  inventory 
at  the  end  of  the  period,  amounting  to  $22,631.40. 

(e)  Close  the  trading  account  into  profit  and  loss  through  the 

journal. 
(/)    Close  the  revenue  accoimts  by  journal  entry  into  the  profit 

and  loss  account. 
(g)    Close  the  balance  of  profit  and  loss  by  joiimal  entry  into  the 

capital  account. 
(A)    Post  all  closing  entries  to  the  ledger  accounts  involved. 

(f)  Make  a  balance  sheet  from  the  accovmts  left  open  on  the 

books. 

(j)  The  personal  accounts,  the  asset  accounts,  and  the  liability 
accounts  not  affected  by  the  journal  dosing  need  not  be 
closed,  except  in  the  case  of  an  annual  dosing  or  in  case  of 
a  transfer  of  the  business,  and  the  opening  of  a  new  set  of 
books.  The  debit  balances  of  these  accounts  should  be 
j  written  in  pencil  to  the  left  of  the  last  debit  entry  before  the 

trial  balance  is  made.  The  credit  balance  of  any  of  these 
accounts  should  be  placed  to  the  left  of  the  last  credit  entry 
before  the  trial  balance  is  made. 

(k)    A\l  ruling  of  accounts  should  be  done  in  red  ink. 

(/)    The  capital  account  should  be  closed  with  a  red  ink  closing. 

2.  Explain  what  is  meant  by  the  depredation  of  a  fixed  asset. 

3.  On  January  31,  1918,  the  Valley  Gh)cery  deddes  to  set  up  a  depre- 
dation reserve  of  $500.00  to  cover  depreciation  of  equipment  and  fixtures, 
and  to  set  up  a  depreciation  fund  of  the  same  amount.  On  July  31,  1918, 
there  was  scrapf>ed  a  cold  drink  fountain  costing  $250.00  and  another  pur- 
chased for  $300.00.  On  January  31,  1919,  there  had  accumulated  $25.00 
of  interest  to  be  turned  jnto  the  sinking  fund.  Journalize  all  of  these  items 
so  that  they  will  be  properly  placed  on  the  books. 


APPORTIONMENT  OF  EXPENSES  129 

During  the  course  of  the  year  extraordinary  repairs  to  the  amount  of 
$150.00  became  necessary,  but  half  of  this  expense  is  deferred  to  the  follow- 
ing year.  Make  the  proper  closing  entries  and  the  required  opening  entry 
for  the  extraordinary  repairs  account  on  February  i. 

4.  A  machinery  asset  cost  originally  $500.00.  It  is  estimated  that  the 
machine  will  last  four  years  and  have  a  scrap  value  at  the  end  of  that  time 
of  $100.00.  If  a  constant  rate  of  depreciation  is  applied  to  the  diminishing 
value  of  the  asset  from  year  to  year,  what  rate  must  be  charged? 

5.  Suppose  that  the  machinery  asset  just  mentioned  is  to  be  depreci- 
ated by  a  constant  charge  each  year  for  both  repairs  and  depreciation,  and 
that  the  total  amount  to  be  charged  is  $600.00.  For  the  first  year  the  outlay 
for  repairs  is  $20.00;  for  the  second  year,  $25.00.  Make  the  journal  entries 
required  at  the  close  of  each  of  the  two  years  in  connection  with  the  depre- 
ciation and  repair  accounts. 


CHAPTER  X 

CLOSING  AND  OPENING  ENTRIES  INVOLVED  IN  THE 
TRANSFER  OF  A  BUSINESS 

1.  Formal  Closings.  —  At  stated  intervals,  such  as  once  a 
year,  along  with  an  audit  of  the  books,  there  is  a  formal  closing 
of  all  the  accounts  kept  by  the  business.  For  the  purpKJse  of 
calculating  profits  from  time  to  time,  there  are  frequently  clos- 
ings at  shorter  intervals.  If  an  inventory  is  taken  at  these 
shorter  intervals,  all  the  accounts  closing  into  profit  and  loss 
are  closed  through  the  general  journal,  and  the  cash  account 
and  the  capital  account  in.  the  usual  way.  The  other  accounts 
are  ordinarily  left  open,  with  the  balances  in  the  memorandum 
spyaces,  as  indicated  in  previous  closings.  If  the  business  is 
transferred  to  a  new  concern  and  a  new  set  of  books  opened,  the 
accounts  on  the  old  books  are  closed  by  a  general  journal  entr}'. 

2.  Example  of  Closing.  —  Let  us  assume  that  John  Smith , 

owner  of  the  Urban  Furniture  Store,  is  to  become  a  partner  in 

the  Valley  Furniture  Comjiany  through  the  transfer  to  the 

company  of  his  individual  business  assets  and  liabilities,  as 

follows: 

URBAN  FURNITURE  STORE 

Balance  Sheet,  December  31,  1919 

I  Assets  Liabilities 

Cash                               $500.00      Notes  Payable  $1,000.00 

St.  Luke  Hospital           1,000.00      Sheboygan  Chair  Co.  2,400.00 

Bagdad  University         2,000.00      Michigan  Bed  Co.  i. 000. 00 

Rice  Manufacturing  Co.    500.00      Wilson  Carjjet  Works  2.100.00 

Hav-wood  Fum.  Co.  2.000.00 

John  Smith,  Capital  23,275.00 


Smith  Institute 

600.00 

J.  H.  Brigham 

400.00 

J.  C.  Riley 

500.00 

Merchandise 

22,275.00 

Fixtures 

1,000.00 

Delivery  Equipment 

3,000.00 

$31,775.00 

$31,775.00 


130 


CLOSING  AND  OPENING  ENTRIES  13 1 

On  the  books  of  the  Urban  Furniture  Store,  the  transfer  of 
the  assets  is  effected  by  the  following  journal  entry: 


Valley  Furniture  Company 

31,77500 

Cash 

500.00 

St.  Luke  Hospital 

1,000.00 

Bagdad  University 

2,000.00 

Rice  Manufacturing  Co. 

500.00 

Smith  Institute 

600.00 

J.  H.  Brigham 

400.00 

J.  C.  Riley 

500.00 

Merchandise 

22,275.00 

Fixtures 

1,000.00 

Delivery  Equipment 

3,000.00 

Transfer  of  assets  to  Valley  Furniture  Company 

If  a  separate  cash  book  has  been  maintained  for  the  cash 
transactions,  the  closing  item  is  entered  in  both  the  cash  book 
and  the  general  journal,  and  checked  in  each  of  these  books  of 
original  entry  to  indicate  that  no  detail  posting  is  required. 

Similarly,  the  liabilities  of  the  Urban  Furniture  Store  are 
transferred  by  the  following  compound  entry: 


Notes  Payable 

1,000 

.00 

Sheboygan  Chair  Co. 

2,400 

.00 

Michigan  Chair  Co. 

1,000 

.00 

Wilson  Carpet  Works 

2,100. 

,00 

Haywood  Furniture  Co, 

2,000, 

,00 

John  Smith,  Capital 

23,275' 

00 

Valley  Furniture  Company 

31,77500 

Transfer  of  liabilities,  including  capital, 

to  Valley  Furniture  Company 

The  account  with  the  Valley  Furniture  Company  is,  of 
course,  opened  merely  for  the  purpose  of  showing  that  the  busi- 
ness has  been  transferred  to  this  new  concern. 

3.  Entry  of  Transfer  on  Books  of  Valley  Furniture  Company. 
—  There  are  several  methods  of  entering  the  assets  and  liabil- 
ities taken  over  from  John  Smith  in  the  formation  of  the  new 
partnership  relation.  The  simplest  way  is  obviously  to  enter 
the  assets  as  debits  and  the  liabilities,  including  the  capital,  as 
credits  to  the  Valley  Furniture  Company.     This  compound 


132  ACCOUNTING  PRINCIPLES 

entry  is  not  only  the  simplest,  but  also  the  most  reasonable 
entry,  in  view  of  the  usual  relation  of  debits  and  credits.  When 
an  asset  comes  into  a  business,  the  general  rule  requires  that 
the  asset  account  in  question  be  debited  and  the  account  repre- 
senting the  source  of  the  asset  be  credited,  the  liabilities  repre- 
senting the  sources  from  which  the  assets  are  secured.  The 
setting  down  of  the  assets,  therefore,  as  debits  and  of  the  lia- 
bilities and  proprietorship  as  offsetting  credits  for  the  journal 
opening  is  defensible,  not  only  as  the  simplest  method,  but  also 
as  the  most  accurate  representation  of  the  important  relation  of 
assets  and  liabilities. 

Accordingly,  the  transfer,  of  the  assets,  liabilities,  and  pro- 
prietorship of  the  Urban  Furniture  Store  is  set  up  on  the  books 
of  the  Valley  Furniture  Company  by  the  following  journal  entry: 


Cash  as  per  Cash  Book 

500.00 

St.  Luke  Hospital 

1,000.00 

Bagdad  University 

2,000.00 

Rice  Manufacturing  Co. 

500.00 

Smith  Institute 

600.00 

J.  H.  Brigham 

400.00 

J.  C.  Riley 

500.00 

Merchandise 

22,275.00 

Fixtures 

1,000.00 

Delivery  Equipment 

3,000.00 

Notes  Payable 

1,000.00 

Sheboygan  Chair  Co. 

2,400.00 

Michigan  Bed  Co. 

1,000.00 

Wilson  Carj)et  Works 

2,100.00 

Ha>ni\ood  Furniture  Co. 

2,000.00 

John  Smith,  Capital 

23,275.00 

Taking  over  of  assets  and  liabilities  of 

Urban  Furniture  Store 

with  John 

Smith  as  partner 

A  question  may  be  raised  in  regard  to  the  cash  entry  in  the 
general  journal.  The  assembly  of  all  the  opening  entries  in  one 
book  of  original  entr\',  however,  has  distinct  value,  and  the 
entry  may  be  defended  on  this  basis.  It  seems  sound  also  on 
theoretical  grounds,  because  the  cash  book  represents  not  only 


CLOSING  AND  OPENING  ENTRIES  133 

a  book  of  original  entry,  but  in  addition  a  cash  account  similar 
to  the  ledger  account  of  the  same  name. 

Another  form  of  opening  entry  is  frequently  advocated  by 
text  writers.  The  purpose  of  this  form  is  to  stress  the  fact 
that  the  Valley  Furniture  Company  has  taken  over  the  assets 
and  assumed  the  definite  liabilities  of  the  Urban  Furniture 
Store,  and  that  the  new  partner's  actual  investment  is  the  dif- 
ference between  the  two.  Consequently,  the  transfer  of  the 
assets  and  liabilities  is  under  the  second  method  journalized  as 
follows: 


Cash  as  per  Cash  Book 

500.00 

St.  Luke  Hospital 

1 ,000 .  00 

Bagdad  University- 

2,000.00 

Rice  Manufacturing  Co. 

500.00 

Smith  Institute 

600.00 

J.  H.  Brigham 

400.00 

J.  C.  Riley 

500.00 

Merchandise 

22,275.00 

Fixtures 

1,000.00 

Delivery  Equipment 

3,000.00 

John  Smith,  Capital 

3i'775oo 

Transfer  of  the  assets  of  the  Urban 
Furniture  Store 

John  Smith,  Capital  8,500.00 

Notes  Payable  i  ,000 .  00 

Sheboygan  Chair  Co.  2,400.00 

Michigan  Bed  Co.  1,000.00 

Wilson  Carpet  Works  2 , 1 00 .  00 

Haywood  Furniture  Co.  2,000.00 

Assumption  of  the  liabilities  of  the 
Urban  Furniture  Store 

If  the  charge  and  credit  to  John  Smith,  Capital,  are  posted, 
the  balance  of  the  capital  account  will  be  §23,275.00  or  the 
same  as  in  the  other  form  of  entry. 

4.  Opening  Entries  for  Consolidation  of  Two  Individual 
Businesses.  —  In  the  example  used  above,  it  is  assumed  that 
the  business  of  the  Urban  Furniture  Store  is  transferred  to  the 
Valley  Furniture  Company  and  entered  on  the  books  of  the 
latter    concern.      The    Valley    Furniture    Company    is    thus 


134  ACCOUNTING  PRINCIPLES 

changed  from  an  individual  business  to  a  partnership,  though 
continuing  to  operate  under  the  original  firm  name.  If  two  in- 
dividual concerns  are  consolidated  and  taken  over  by  a  new 
general  partnership,  each  of  the  individual  businesses  is  under 
the  necessity  of  closing  its  books  and  making  a  formal  transfer. 
On  the  books  of  the  new  firm,  the  transfer  of  the  assets  and  lia- 
bilities of  the  old  concerns  is  set  up  in  the  manner  indicated  in 
the  preceding  section.  The  assets  and  liabilities  of  each  of  the 
old  firms  are,  of  course,  treated  as  separate  entries,  there  being 
no  consolidation  of  accounts  of  the  same  name  until  after  a 
journal  record  of  each  transfer  has  been  made. 

5.  Capital  Accounts  of  Partners.  —  The  books  of  a  partner- 
ship are  similar  to  those  of  an  individual  business,  except  that 
there  are  two  or  more  capital  accounts  instead  of  simply  one, 
and  that  the  net  profit  item  must  be  divided  between  or 
among  the  partners  before  being  closed  into  the  capital  ac- 
counts. The  closing  entry  of  the  profit  and  loss  account,  in  the 
case  of  a  credit  balance,  has  in  the  case  of  an  individual  busi- 
ness been  a  debit  of  net  profit  to  profit  and  loss  and  a  credit  to 
the  individual  capital  account.  In  a  partnership,  the  debit  is 
the  same,  but  the  credit  is  in  fixed  ratios  to  the  capital  ac- 
counts of  the  several  partners.  As  the  profits  and  losses  of  a 
general  partnership  are  divided  equally,  unless  otherwise  speci- 
fied in  the  partnership  agreement,  a  credit  balance  of  $300.00 
in  the  profit  and  loss  account  is  closed  into  the  capital  ac- 
counts of  John  Smith  and  John  Doc  by  the  following  entry: 

Profit  and  Loss  —  Net  Profits  300 .  00 

John  Smith,  Capital  150.00 

John  Doe,  Capital  150.00 

Closing  of  profit  and  loss  into  capital 
accounts 

Withdrawals  by  the  partners  of  cash  or  goods  are  charged  to 
their  separate  personal  accounts,  which  are  later  closed  into 
their  individual  capital  accounts,  just  as  the  personal  account 
of  the  single  owner  is  closed  into  the  one  capital  account. 


CHAPTER  XI 
APPORTIONMENT  OF  INCOME  AND  EXPENSE 

1.  Definition  of  Accrued  Income.  —  Whenever  an  asset  is  re- 
ceived without  the  equal  sacrifice  of  another  asset,  an  income 
results.  Although  expense  is  generally  incurred  in  connection 
with  the  receipt  of  such  income  items,  the  latter  are  closed  as 
credits  into  profit  and  loss,  the  expense  being  also  closed  into 
profit  and  loss,  but  on  the  debit  side.  The  credit  balance  of 
the  account  represents  the  net  profits  or  the  net  income  earned. 
In  other  words,  income  items  are  received  subject  to  such  ex- 
pense deductions  as  may  arise  in  the  conduct  of  the  business. 

Certain  items  are  treated  as  income  for  a  reason  similar  to 
that  involved  in  depreciation  charges,  which  are  made  for  the 
purpose  of  bringing  about  an  equitable  distribution  of  expense 
over  the  successive  periods  covered  by  statements  of  profit  and 
loss.  For  instance,  it  may  take  a  year  to  earn  a  certain  in- 
come, the  receipt  of  it  at  the  end  of  that  time  being  contractu- 
ally assured.  If  two  statements  of  profit  and  loss  are  made 
during  the  year  and  all  of  the  income  is  credited  to  the  second 
period,  the  profits  of  the  two  periods  cannot  be  fairly  com- 
pared. If  the  income  is  an  annual  interest  payment  on  notes 
receivable,  and  is  due  on  December  31,  a  closing  on  June  30 
should  have  credit  for  half  of  the  amount;  for  clearly  half  of 
the  interest  has  been  earned,  even  though  it  is  not  due  until 
the  end  of  the  second  half  of  the  year.  Items  thus  earned  but 
not  due  are  scheduled  as  accrued  income,  and  must  be  taken 
account  of  in  closing,  so  that  the  profits  of  one  period  may 
be  comparable  with  those  of  earlier  or  later  periods. 

2.  Treatment  of  Accrued  Income.  —  Accrued  income  is  en- 
tered as  an  asset  in  the  balance  sheet  by  means  of  an  accrued 
income  account,  which  is  opened  only  in  connection  v/ith  the 
closing  of  the  books.    If  the  accrued  interest  receivable  on  De- 

135 


136  ACCOUNTING   PRINCIPLES 

cember  31  is  $1,000.00,  then  the  interest  earned  on  June  30  is 
$500.00,  and  on  closing  is  entered  as  follows: 

Accrued  Income  Not  Due  —  Interest      500.00 

Interest  500 .  00 

Placing  of  accrued  interest  on  the  books 

When  the  whole  amount  of  the  interest  is  paid  on  Decem- 
ber 31,  the  following  journal  entry  is  made: 

Cash  ijOoo.oo 

Interest  1,000.00 

Receipt  of  interest  on  notes  receivable 

This  entry  alone  would  result  in  an  excessive  credit  to  inter- 
est for  the  second  period.  To  obviate  this  difficulty,  the  pre- 
vious closing  entr\'  is  reversed  after  the  closing  of  the  books  on 
Jime  30  by  the  following  opening  entr>-: 

Interest  500 .  00 

Accrued  Income  Not  Due  —  Interest  500 .  00 

Reversal  of  accrued  interest  entry  to 
reopen  the  interest  account. 

With  this  reversing  entry  and  the  final  credit  of  $1,000.00,  there 
results  a  credit  balance  of  $500.00  for  the  second  half  of  the 
year,  which  is  the  same  amount  credited  to  the  interest  account 
for  the  preceding  period.  In  other  words,  these  entries  make  a 
fair  apportionment  of  the  interest  earnings  between  the  first 
and  the  second  period  of  the  year. 

As  rents,  royalties,  and  other  incomes  due  at  stated  periods 
are  treated  'n  the  same  way,  the  journal  memoranda  showing 
the  nature  of  the  accrued  items  are  entered  both  in  the  ledger 
and  in  the  balance  sheet  For  example,  f  in  addition  to  the 
accrued  interest  there  should  be  accrued  rents  of  $300.00  and 
accrued  royalties  of  $150.00,  the  several  items  are  entered  on 
the  asset  side  of  the  balance  sheet  as  follows: 


950.00 


Accrued  Income  Not  Due 

Interest 

500.00 

Rents 

300.00 

Royalties 

150.00 

APPORTIONMENT  OF  INCOME  AND   EXPENSE        137 

3.  Accrued  Expense  and  Accrued  Accounts  Payable.  —  The 

problem  of  accrued  expense  is  similar  to  that  of  accrued  in- 
come. Payment  for  a  loan  or  facility  may  be  made  at  the  close 
of  the  year.  As  a  result,  the  profits  of  the  first  half  of  the  year 
cannot  be  properly  compared  with  the  profits  of  the  second 
half  unless  the  expense  incurred  for  the  whole  year's  operation 
is  correctly  apportioned  between  the  two  periods.  If  interest 
to  the  amount  of  $400.00  is  paid  December  31  on  a  note  pay- 
able, half  of  the  interest  has  accrued  on  June  30,  and  is  entered 
on  the  books  at  the  mid-year  closing  by  means  of  the  following 
journal  entry: 

Interest  200 .  00 

Accrued  Accounts  Payabje  —  Interest  200 .  00 

Placing  of  accrued  interest  payable  on 
the  books 

As  the  accrued  accounts  payable  account  is  opened  only  for 
the  purpose  of  facilitating  the  closing  of  the  books,  the  follow- 
ing reversing  entry  must  be  made  to  reopen  the  books  for  the 
succeeding  period: 

Accrued  Accounts  Payable  —  Interest     200 .  00 

Interest  200.00 

Reversal  of  accrued  interest  entry  to 
reopen  interest  account 

After  this  entry  has  been  posted,  the  accrued  accounts  payable 
account  is  closed  and  the  interest  account  reopened  with  a 
credit  balance  of  $200.00  for  the  second  half  year. 

When  the  payment  of  the  interest  is  finally  made  on  Decem- 
ber 31,  the  outlay  is  journalized  as  follows: 

Interest  400 .  00 

Cash  400 . 00 

Payment  of  interest  on  notes  payable 

The  posting  of  this  interest  charge  results  in  an  interest  debit 
balance  of  $200.00,  which  is  an  amount  equal  to  that  charged 
to  the  preceding  period.  By  means  of  these  entries,  therefore, 
the  annual  interest  payment  has  been  equitably  distributed  be- 
tween the  two  half  vears. 


138  ACCOUNTING  PRINCIPLES 

Accrued  accounts  payable  represent,  of  course,  a  liability. 
As  this  liability  may  consist  of  accrued  interest,  accrued  taxes, 
accrued  wages,  accrued  rent,  or  any  other  accrued  expense 
which  is  payable  at  stated  times  and  apportionable  over  a  num- 
ber of  periods,  the  journal  memoranda  showing  the  nature  of 
the  items  should  be  entered  in  the  ledger  memorandum  space, 
so  that  a  proper  analysis  of  the  accrued  accounts  payable  ac- 
count may  be  made  in  the  balance  sheet. 

4.  Deferred  Expense.  —  The  matter  of  deferred  expense  was 
referred  to  in  Chapter  IX  in  the  discussion  of  the  treatment  of 
extraordinarj'  repairs.  There  are  many  expenses  which  are 
pjaid  in  one  period  but  properly  chargeable  over  a  much  longer 
time.  For  instance,  an  insurance  premium  may  be  paid  in  ad- 
vance for  three  or  five  years.  It  is  clear  that  such  an  expense 
should  be  apportioned  in  equal  amounts  to  the  three  or  five  years 
for  which  the  policy  is  secured.  If  the  premium  payment  is 
$60.00  for  three  years,  the  expenditure  is  journalized  as  follows: 

Insiu^ance  60.00 

Cash  6o.cx> 

Premiiun  for  three  years  on  fire  insur- 
ance policy 

As  only  $20.00  of  the  outlay  is  chargeable  to  expense  at  the 
close  of  the  first  year,  the  remainder  must  be  deferred  to  the 
succeeding  period  by  means  of  the  following  journal  entry: 

Deferred  Expense  —  Insiurance  40 .  00 

Insurance  40 .  00 

Deferment  of  part  of  the  insurance  ex- 
pense 

After  the  balance  of  the  insurance  charge  has  been  c'osed 
into  profit  and  loss,  another  journal  entry  must  be  made  for 
the  purpose  of  reopening  the  insurance  account  and  closing  the 
deferred  expense  account,  which  is  opened  mere'y  to  facilitate 
the  closing  of  the  account.  The  proper  reversing  entry  is,  of 
course,  the  following: 

Insurance  40 .  00 

Deferred  Expanse  —  Insxirance  4°  •  00 

Reversal  of  the  deferred  expense  entry 
to  reopen  the  insurance  account 


APPORTIONMENT  OF  INCOME  AND   EXPENSE        139 

At  the  end  of  the  second  year,  another  $20.00  is  charged  as 
expense  to  profit  and  loss,  the  remaining  $20.00  being  deferred 
to  the  last  year  by  means  of  a  deferring  and  reversing  entry 
similar  to  those  employed  at  the  close  of  the  previous  year.  At 
the  end  of  the  third  year  the  balance  of  the  original  expendi- 
ture is  closed  into  profit  and  ]oss. 

A  more  abbreviated  way  of  treating  the  entries  is  to  set  up 
both  an  expense  and  asset  account.  The  expense  account  may 
be  called  insurance  and  the  asset  item  unexpired  insurance,  or 
insurance  paid  in  advance.  The  entry  of  the  original  $60.00  for 
the  three-year  policy  would  be  as  follows: 

Unexpired  Insurance  60 .  00 

Cash  ,         60 .  00 

Purchase  of  three-year  insurance  policy 

At  the  end  of  the  year  when  it  would  be  necessary  to  charge 
$20.00  of  the  amount  to  the  expenses  for  the  year  the  following 
entry  could  be  made: 

Insurance  20 . 00 

Unexpired  Insurance  20.00 

Charging  $20.00  to  insurance  expense 

The  advantage  of  this  treatment  is  that  it  requires  no  reversing 
entry.  All  of  the  other  items  of  deferred  expense  may  be 
treated  in  the  same  way.  If  several  of  these  items  are  treated 
without  the  use  of  the  deferred  expense  account,  it  is  still  ad- 
vantageous to  group  the  several  items  on  the  asset  side  of  the 
balance  sheet  under  the  heading  of  deferred  expense  as  follows: 


Deferred  Expense: 

Unexpired  Insurance 

40.00 

Rent  Paid  in  Advance 

75.00 

Advertising 

125.00 

240.00 

Interest,  rent,  and  other  expense  items  that  are  paid  in  ad- 
vance to  cover  a  period  longer  than  that  covered  by  the  first 
closing  after  the  expense  has  been  incurred  are  treated  in  a 
similar  manner.  If  the  expenditure  for  advertising  for  a  given 
year  is  unusually  large,  that  too  should  be  deferred  in  part  for 


I40  ACCOUNTING  PRINCIPLES 

the  purpose  of  making  the  amount  of  this  expense  approxi- 
mately the  same  from  year  to  year,  unless  the  larger  expendi- 
ture clearly  affects  only  the  income  of  the  year  in  which  it  is 
made.  Large  advertising  expense  frequently  affects  the  income 
of  the  business  for  many  years,  and  tends  to  create  a  permanent 
goodwill  that  may  be  sustained  by  annual  expenditures  much 
lower  than  those  made  in  the  earlier  periods  of  the  business. 

It  is  commonly  regarded  as  conservative  accounting  practice 
to  include  organization  expense  as  a  deferred  expense  to  be  ap- 
portioned over  a  period  of  years,  perhaps  five  or  more.  There 
is,  however,  no  sound  theoretical  basis  for  such  a  treatment. 
The  expenses  of  organization  provide  an  asset  which  is  owned 
as  long  as  the  business  exists  as  a  going  concern  and  upon 
which  the  business  may  earn  in  competition  with  other  con- 
cerns, which  must  incur  a  similar  investment  before  entering 
the  field.  In  other  words,  only  those  assets  should  be  depre- 
ciated which  last  but  a  term  of  years.  Conversely,  no  asset 
should  be  depreciated  unless  it  wears  out,  becomes  obsolete,  or 
for  some  other  reason  ceases  to  serve  the  purpose  for  which  it 
was  originally  purchased. 

5.  Deferred  Income.  —  An  expense  paid  in  advance  by  one 
firm  may  be  an  income  received  in  advance  by  another.  An  in- 
surance company  receiving  premiums  three  years  in  advance 
does  not  apportion  all  of  this  income  to  the  year  in  which  it  is 
received,  nor  would  a  newspaper  receiving  subscriptions  for  a 
year  in  advance  credit  all  of  this  income  to  the  first  half  of  the 
year  if  the  books  are  closed  twice  during  the  annual  period.  If 
the  annual  advance  subscriptions  received  by  the  newspaper  on 
January  i  total  $10,000.00,  the  receipt  is  journalized  as  follows: 

Cash  10,000.00 

Subscriptions  10,000 .  00 

Subscriptions  received  in  advance 

In  closing  the  books  on  June  30,  credit  is  taken  by  means  of 
the  following  entry  for  only  half  of  the  total  amount: 

Subscriptions  5 ,000 .  00 

Deferred  Income  —  Subscriptions  5,000.00 

Deferment  of  part  of  subscription  receipts 


APPORTIONMENT  OF  INCOME  AND  EXPENSE       141 

The  remaining  $5,000.00  of  the  subscription  account  is,  of 
course,  credited  to  profit  and  loss  in  the  usual  way. 

As  the  deferred  income  account  is  opened  only  for  the  purpose 
of  apportioning  income  properly  at  the  time  of  closing,  the  defer- 
ring entry  must  be  reversed  to  reopen  the  subscription  account 
for  the  subsequent  period.  This  is  effected  by  means  of  the  fol- 
lowing journal  entry: 

Deferred  Income  —  Subscriptions         5,000.00 

Subscriptions  5,000.00 

Reversal  of  deferred  income  entry  for 
purpose  of  reopening  subscription 
account 

At  the  close  of  the  second  period,  the  deferred  income  of 
$5,000.00  is,  of  course,  closed  into  profit  and  loss. 

The  deferred  income  account  obviously  appears  on  the  liabil- 
ity side  of  the  balance  sheet,  its  treatment  in  this  respect  being 
precisely  the  opposite  of  the  deferred  expense  account.  De- 
ferred expense  may  be  thought  of  as  a  receivable  from  a  subse- 
quent period.  If  this  is  done,  deferred  income  clearly  becomes 
a  payable  to  a  subsequent  time. 

It  is  possible  to  treat  deferred  income  without  the  use  of  a  de- 
ferred income  account  and  without  the  reversing  entry  at  the  time 
of  reopening  the  books.  The  income  deferred  can  be  treated  as  a 
reserve  account  and  the  amount  charged  against  it  in  closing 
the  books  is  the  amount  credited  to  income  for  the  period.  In 
the  subscription  illustration  there  would  be  an  unearned  sub- 
scription account  and  a  subscriptions  earned  account.  The  sub- 
scriptions received  in  advance  would  be  credited  to  the  un- 
earned subscription  account.  The  following  journal  entry  would 
be  made  in  recording  the  $10,000.00  of  subscription  referred  to 
above: 

Cash  10,000.00 

Unearned  subscriptions  10,000 .  00 

Subscriptions  received  in  advance 

At  the  end  of  the  six  months  period  half  of  the  total  could  be 
either  credited  directly  to  profit  and  loss  as  subscriptions 
earned  or  the  credit  could  be  made  to  a  subscripiions  earned  ac- 


142  ACCOUNTING   PRINCIPLES 

count  which  would  be  closed  into  profit  and  loss.  If  the  closing 
entry  were  the  only  credit  to  the  subscriptions  earned  account 
the  closing  entry  would  be  made  to  profit  and  loss  as  follows: 

Unearned  subscriptions  5,000.00 

Profit  and  Loss  —  Subscriptions  earned  5, 000 .  00 

Crediting  profit  and  loss  with  the  period's 
share  of  the  subscriptions  earned 

The  balance  of  the  unearned  subscription  account  would  then 
be  carried  to  the  liability  side  of  the  balance  sheet  as  deferred 
income  or  income  reserved  for  credit  to  later  periods. 

It  might  be  true,  however,  that  some  of  the  subscriptions 
would  be  received  at  the  expiration  of  the  year  for  which  the 
papers  were  received  so  that  credits  would  be  made  from  time 
to  time  during  the  period  to  the  subscriptions  earned  account. 
Under  such  circumstances  the  part  of  unearned  subscriptions 
credited  to  profit  and  loss  would  go  first  to  the  subscriptions 
earned  account,  which  would  then  be  closed  into  profit  and  loss 
by  the  following  entries: 

Unearned  Subscriptions  5,000.00 

Subscriptions  Earned  5>ooo .  00 

Crediting  the  period  with  its  share  of 
subscriptions  earned 

Assuming  the  subscriptions  earned  account  had  already  to  ts 
credit  $7,500.00,  then  it  would  be  closed  to  profit  and  loss  by 
the  following  journal  entry: 

Subscriptions  earned  7 ,  500 .  00 

Profit     and     Loss  —  Subscriptions 

Earned  7,500.00 

Closing  subscriptions  earned  into  profit 

and  loss 

The  fact  that  the  form  of  entry  involving  the  deferred  income 
account  is  frequently  used  makes  it  necessary  to  understand 
the  procedure.  It  is,  however,  more  involved  and  less  satisfac- 
tory than  the  usage  involved  in  the  two  accounts  of  unearned 
subscriptions  and  earned  subscriptions 


APPORTIONMENT  OF   INCOME  AND   EXPENSE        1 43 

6.  Reserve  for  Bad  Debts.  —  It  has  been  found  by  experi- 
ence that  a  certain  percentage  of  accounts  receivable  prove  to 
be  bad  or  uncollectible,  and  failure  to  take  account  of  such 
losses  results  in  an  overstatement  of  the  net  profits  from  year 
to  year.  If  the  losses  from  this  source  were  the  same  each 
year,  they  could  be  charged  to  expense  as  they  arise,  and  there 
would  be  no  need  of  providing  for  an  even  distribution  of  them 
over  the  good  and  the  bad  years.  Inasmuch,  however,  as  the 
large  losses  of  bad  years  may  be  due  entirely  to  circumstances 
beyond  the  control  of  the  management,  such  exceptional  losses 
must  clearly  be  treated  as  a  deferred  expense  or  must  be  pro- 
vided for  in  advance.  The  latter  method  is  the  one  commonly 
employed,  a  valuation  reserve  being  set  up  against  accounts  re- 
ceivable or  notes  receivable,  or  against  both  of  these  accounts. 
At  the  end  of  each  period,  a  certain  per  cent  of  the  credit  sales, 
as  determined  by  experience,  is  charged  to  the  account  of  losses 
from  bad  debts  and  at  the  same  time  credited  to  the  bad  debt 
reserve.  If  the  bad  debts  are  estimated  at  two  per  cent  of  the 
credit  sales  and  the  latter  amount  to  $100,000.00,  the  journal 
entry  providing  for  losses  imder  this  head  is  as  follows: 

Losses  from  Bad  Debts  2,cxx).oo 

Reserve  for  Bad  Debts  2,000.00 

Setting  up  of  a  reserve  for  bad  debts 

The  debit  element  of  this  entry  is,  of  course,  closed  into  profit 
and  loss  in  the  usual  way. 

After  the  creation  of  the  bad  debt  reserve,  losses  arising  from 
the  default  or  insolvency  of  debtors  are  charged  directly  to  this 
account.  For  instance,  if  the  loss  in  the  account  of  John  Smith 
is  $250  00,  the  mount  is  marked  off  by  the  following  journal 
entry: 

Reserve  for  Bad  Debts  250.00 

John  Smith  250.00 

Charging  off  the  account  of  John  Smith 
on  account  of  insolvency 

If  the  average  annual  losses  fall  far  below  the  amount  set 
aside  each  year  to  the  bad  debt  reserve,  the  latter  becomes  in 


144  ACCOUNTING  PRINCIPLES 

effect  an  addition  to  capital.  Whenever  such  a  condition  arises, 
the  excess  in  the  reserve  should  be  credited  to  the  capital  ac- 
count, and  the  annual  charge  to  losses  from  bad  debts  should 
be  decreased  so  as  to  bring  the  bad  debt  reser\'e  within  an 
amount  safely  necessar\^  to  cover  probable  losses. 

As  the  reserve  for  bad  debts  is  a  valuation  account,  similar 
to  the  reserves  for  depreciation,  it  is  entered  in  the  balance 
sheet  as  a  deduction  from  the  assets  against  which  it  is  accu- 
mulated. Assuming  that  the  accounts  receivable  were  Sioo,- 
ooo.oo  and  that  the  reserve  for  bad  debts  at  the  date  of  closing 
was  $7,500.00,  the  items  on  the  asset  side  of  the  balance  sheet 
would  appear  as  follows: 

Accounts  Receivable  $100.000. co 

Less  Reserve  for  Bad  Debts  7.500.00   $92,500.00 

QUESTIONS  AND  PROBLEMS 

1.  What  is  an  income? 

2.  WTiat  is  meant  bj-  e.xpense? 

3.  The  Valley  Xeu-s  received  subscriptions  a  year  in  advance  as  f<^ows: 

Januarj'  i  $5000.00 

February-  i  6000.00 

March  1  4000.00 

April  I  4500.00 

May  I  3000.00 

June  I  2000.00 

On  June  30  the  bookkeeper  closes  his  books,  ^^"hat  entries  would  he 
make  to  property  close  the  subscription  account  into  profit  and  loss? 

What  journal  entrj-  affecting  subscriptions  should  be  made  in  reopening 
the  books  on  July  i? 

4.  On  January  i  the  \'alley  Book  Store  discounted  its  $600.00  note  at 
the  bank  at  S'^  for  si-x  months,  getting  credit  at  the  bank  for  the  face  of  the 
note  less  the  discount.  On  March  31  the  books  are  closed.  Make  the 
entr\'  required  to  properly  apportion  the  interest  expense  involved  in  the 
discount  of  the  note.  What  entr>'  should  be  made  in  reopening  the  interest 
accoimt  April  i  so  far  as  this  item  is  concerned? 

5.  The  ^"alley  National  Bank  closed  its  books  June  30.  Of  the  total 
interest  received  $3,000.00  was  deferred.  It  foimd  also  that  $2,500.00  of 
interest  had  accrued  on  bonds  owned.  It  also  had  $500.00  in  wages  and 
$200.00  in  rent  which  were  accrued  and  unpaid. 

Make  appropriate  closing  entries  for  these  items.  Make  also  the  entries 
to  re(^)en  the  accounts  July  i. 


APPORTIONMENT  OF  INCOME  AND   EXPENSE        145 

6.  The  Rational  Biscuit  Co.  closed  its  books  June  30.  The  Valley 
Grocery  Co.,  one  of  its  customers,  having  an  account  of  $750.00,  went  into 
bankruptcy  and  was  fuUy  liquidated  in  June.  General  creditors  received 
fifty  cents  on  the  dollar.  The  Rational  Biscuit  Co.  received  its  check  on 
June  20. 

In  closing  on  June  30  the  Company  made  its  usual  credit  of  Si, 000.00  to 
Reserve  for  Bad  Debts.  It  had  spent  during  the  six  months  $20,000.00  in 
advertising  and  decided  to  defer  one  half  of  this. 

Enter  all  the  above  items  into  the  journal.  Make  the  opening  entry 
July  I  for  the  advertising  account. 


CHAPTER  Xn 

INTERPRETATION  AND  MANAGERIAL  USE  OF  THE 
REVENUE  STATEMENT 

I.  Basis  of  the  Grouping  of  Accounts  in  the  Revenue  State- 
ment. —  The  general  purpose  of  the  revenue  statement  was  ex- 
plained in  Chapter  II,  the  outline  there  given  being  for  a  small 
merchandise  business.  The  number  of  accounts  entering  into 
the  revenue  statement  is  determined  partly  by  the  number  of 
commodities  and  services  involved  in  the  business  and  partly 
by  the  amount  of  the  expenditures  for  each.  If  the  total  outlay 
for  a  given  commodity  is  large,  the  expenditures  for  the  com- 
modity are  brought  together  in  a  separate  account,  so  that  the 
management  'may  plan  economi;s  in  its  purchase  and  guard 
against  waste  in  its  use.  For  instance,  if  a  large  amount  of  fuel 
is  purchased  annually,  a  fuel  account  is  ordinarily  entered  on 
the  books.  The  various  commodity  accounts,  in  turn,  are  classi- 
fied under  the  cost  of  the  services  of  which  the  accounts  form  a 
part.  This  grouping  of  accounts  according  to  the  service  into 
which  they  enter  may  be  called  a  functional  classification.  The 
various  functional  classifications  are  further  grouped  according 
to  the  administrative  head  or  the  administrative  unit  responsi- 
ble for  the  different  fimctions  or  services  entering  into  the  life 
of  the  business. 

This  underlying  basis  of  the  creation  and  grouping  of  ac- 
counts is  of  great  importance,  and  becomes  increasingly  so 
with  a  growth  in  the  size  and  complexity  of  the  business.  The 
sundry  and  miscellane  us  accounts  should  be  used  only  to 
include  small  items  that  are  not  otherwise  provided  for  in 
the  accounting  classification.  As  these  particular  accounts  are 
of  very  ittle  managerial  use,  care  should  be  taken  to  see  that 
their  totals  do  not  become  large.  WTien  they  do,  the  accounts 
should  be  further  analyzed  as  to  the  cmmodities  o  services 
secured  for  the  outlays.    In  other  words,  the  accounts  showing 

146 


MANAGERIAL  USE  OF   REVENUE   STATEMENT        1 47 

the  commodities  and  services  purchased  should  include  all  but 
a  small  fraction  of  the  total  expenditures. 

No  classification  of  accounts  should  be  made  for  any  busi- 
ness until  an  analysis  has  been  made  of  the  organization  of  the 
business  under  consideration.  The  grouping  of  accounts  ac- 
cording to  the  administrative  units  has  the  advantage  of  fur- 
nishing information,  not  only  to  the  head  of  each  division  as  to 
the  operating  results  of  a  particular  unit,  but  to  the  general 
manager  as  to  the  operating  results  of  the  business  as  a  whole. 
There  is  a  growing  tendency  in  commercial  enterprises  to  de- 
partmentalize business  activity,  and  to  hold  some  one  individ- 
ual responsible  for  the  results  achieved  in  a  department  As 
a  result,  the  accounts  created  and  their  grouping  in  the  revenue 
statement  should  be  such  that  the  administrative  officers  of  the 
different  units  and  the  general  manager  of  the  business  will 
have  a  proper  basis  for  considering  the  problems  of  the  various 
units  or  the  efficiency  of  their  personnel. 

2.  Frequency  of  Closing  the  Accounts.  —  The  growing  ten- 
dency to  make  larger  administrative  use  of  accounting  data  is 
bringing  about  more  frequent  closings  of  the  books.  Without 
such  closings,  it  is  of  course  impossible  to  ascertain  the  results 
of  operation  or  the  condition  of  the  business  from  time  to  time. 
Monthly  closings  are  becoming  quite  frequent,  while  much 
statistical  data  are  taken  from  the  books  daily  and  weekly  for 
the  purpose  of  keeping  check  on  the  efficiency  of  operation. 
Some  concerns  go  so  far  as  to  show  a  daily  tabulation  with  es- 
t'mated  profits. 

3.  Fixed  Costs.  —  An  examination  of  published  revenue 
statements  and  the  writings  of  well-known  accounting  authors 
will  show  that  considerable  attention  has  been  given  to  gather- 
ing together  a  group  of  items  designated  as  fixed  charges.  Lit- 
tle has  been  done,  however,  toward  pointing  out  their  use  and 
business  significance.  These  have  either  been  presumed  to  be 
commonly  understood,  or  have  been  left  by  common  consent  to 
each  business  executive  for  his  own  determination. 

Perhaps  the  first  impression  to  be  formed  regarding  fixed 
charges  is  that  no  great  amount  of  attention  need  be  paid  to 


148  ACCOUNTING  PRINCIPLES 

them  in  the  management  of  the  business,  because  so  little  can 
be  done  toward  changing  the  amount  when  once  contractually 
determined.  They  have,  however,  played  a  larger  role  in  busi- 
ness policy  than  such  casual  consideration  might  seem  to  indi- 
cate. Fixed  costs  must  be  met  regardless  of  the  volume  of 
sales.  A  certain  outlay  or  investment  is  made  to  provide  the 
organization  and  facilities  to  carry  on  a  certain  volume  of  busi- 
ness, but  a  failure  to  realize  this  anticipated  volume  does  not 
produce  a  corresponding  reduction  in  the  fixed  charges,  those 
having  been  determined  in  connection  with  the  original  set-up. 
A  business  thus  operating  below  its  capacity  suffers  of  course  a 
disadvantage  in  competition  with  concerns  more  favorably  sit- 
uated, and,  under  freely  competitive  conditions,  provided  the 
fixed  investment  is  large,  must  sell  its  goods  at  a  price  insuffi- 
cient to  produce  the  usual  return  on  the  investment  and  also  to 
pay  the  fixed  charges.  Under  such  conditions,  the  price  is  fre- 
quently lowered  to  cover  no  more  than  the  costs  other  than  the 
fixed  charges  until  a  larger  volume  of  business  is  secured.  An 
alternative  and  sometimes  better  course  is  to  maintain  prices 
and  incur  exceptional  expenses  in  the  way  of  advertising  until 
the  business  is  brought  to  its  proper  volume,  even  though 
meantime  the  net  profits  may  not  be  such  as  to  cover  the  fixed 
charges  and  at  the  same  time  yield  a  return  on  the  investment 
that  would  be  satisfactory  in  the  long  run.  If  the  business  se- 
cured by  this  extraordinary  expense  affords  a  return  in  excess 
of  the  additional  expense  involved,  it  reduces  to  that  extent 
the  loss  from  the  fixed  charges. 

While  considerations  of  business  policy  seem  to  call  for  a  dis- 
tinct classification  of  fixed  charges,  the  administrative  or  func- 
tional classification  is  the  predominant  basis  for  account  group- 
ing in  the  revenue  statement,  a  schedule  of  the  fixed  charges 
being  usually  submitted  as  a  separate  exhibit.  Thus,  in  Illus- 
tration No.  16,  below,  there  is  a  group  of  accounts  under  the 
caption,  Maintenance,  Operation,  and  Upkeep  of  Building.  These 
expenses,  though  ordinarily  falling  under  the  supervision  of  one 
of  the  executives  of  the  business,  are  in  the  nature  of  fixed 
charges.     In  order  to  make  a  complete   summary  of    these 


MANAGERIAL  USE  OF   REVENUE  STATEMENT        1 49 

charges,  account  must  be  taken  also  of  items  in  other  groups 
which  vary  little  with  the  volume  of  business  after  provision 
has  once  been  made  for  organization  and  the  insta'lation  of 
equipment.  Telephone  charges,  delivery  expenses,  and  inter- 
est do  not  vary  much  from  month  to  month  and  cannot  be  ig- 
nored in  considering  fixed  costs.  In  other  words,  a  separate 
schedule  of  items  from  various  captions  must  be  made  if  it  is 
desired  to  make  an  accurate  estimate  of  fixed  charges. 

4.  Selling  Expenses.  —  The  selling  organization  of  a  busi- 
ness is  ordinarily  under  the  supervision  of  a  separate  executive 
if  the  business  is  large  enough  to  justify  such  specialization. 
With  the  appointment  of  a  separate  sales  manager,  it  is  logical, 
of  course,  to  group  under  the  general  caption  of  Selling  Ex- 
penses the  accounts  showing  the  cost  of  the  several  services  and 
functions  for  which  he  is  directly  responsible.  Such  grouping 
provides  the  basis  of  valuable  information  to  the  executive  of 
the  sales  department  and  to  the  general  manager  of  the  busi- 
ness as  well. 

In  a  smaller  establishment,  in  the  absence  of  a  special  sales 
executive,  the  grouping  of  the  sales  functions  under  a  separate 
head  becomes  less  important,  though  the  grouping  may  be  em- 
ployed if  there  are  a  sufficient  number  of  employees  to  set  up  a 
division  of  labor  under  this  head.  Where  the  manager  is  at 
once  salesman,  office  manager,  and  caretaker  of  the  establish- 
ment, an  attempt  to  maintain  a  departmental  grouping  of  ac- 
counts and  to  apportion  his  salary  among  the  various  general 
captions  is  hardly  worth  while,  since  the  results  derived  are  of 
practically  no  significance  from  the  managerial  point  of  view. 
Consequently,  the  general  heads  of  the  more  elaborate  organi- 
zation disappear  and  become  combined  under  the  caption  of 
Store  Management.  But,  while  there  is  no  further  need  of  the 
general  caption  of  Selling  Expanses,  subsidiary  captions  show- 
ing the  cost  of  items  easily  segregated,  such  as  advertising, 
rent,  water  and  light,  are  still  maintained. 

5.  Delivery  Expenses.  —  This  group  of  accounts  appears  in 
the  statement  of  any  establishment  which  renders  this  particu- 
lar service.    If  the  total  of  the  expenditures  is  small,  the  group 


I50  ACCOUNTING  PRINCIPLES 

may  become  a  single  account.  Under  any  circumstance,  there 
is  ordinarily  a  division  of  labor  such  that  some  particular  indi- 
vidual is  charged  with  rendering  this  service,  and  therefore  to 
some  extent  responsible  for  its  cost. 

6.  Classification  of  Income.  —  In  a  mercantile  establish- 
ment, as  a  large  percentage  of  the  income  arises  from  sales,  it  is 
desirable  to  know  the  amount  of  the  gross  profits  received  from 
the  various  commodities  and  the  net  income  derived  from  each. 
Information  of  this  kind  is  useful  in  the  determination  of  ad- 
vertising policy,  in  the  choice  of  brands  to  be  carried,  and  in 
the  adjustment  of  purchases  to  the  trade  demand.  Conse- 
quently, in  the  revenue  statement  of  the  departmentalized 
business,  the  total  of  sales  for  each  department  is  shown.  If 
the  business  is  conducted  as  a  single  unit,  the  statement  would 
show  the  amount  of  sales  for  only  the  chief  articles  of  merchan- 
dise. Frequently,  in  order  to  have  a  full  line  with  which  to  at- 
tract trade,  it  is  necessary  to  carry  certain  commodities  for 
which  the  per  annum  volume  of  sales  is  small.  These  items  are 
generally  grouped  together  and  the  amount  of  the  sales  given 
in  a  single  item.  But,  even  in  such  cases,  the  accounting  and 
statistical  data  showing  the  amount  of  purchases  and  sales  for 
each  item  should  be  available  in  such  form  that  an  analysis 
can  be  made  of  the  rapidity  of  the  turnover  of  each  of  the  vari- 
ous classes  of  commodities  carried. 

The  basis  for  the  classification  of  incomes  is  obviously  similar 
to  that  for  the  classification  of  expense.  The  commodities  sold 
represent  the  services  rendered  by  the  business,  and  the  income 
depends  upon  the  volume  of  sales  of  the  various  commodities 
sold  at  a  profit.  In  short,  the  classification  is  primarily  a  com- 
modity classification,  allied  commodities  being  grouped  into 
separate  departments  each  under  the  supervision  of  a  responsi- 
ble head.  By  means  of  such  a  classification,  it  is  possible  to  ar- 
rive at  not  only  the  gross  profits  made  by  each  department  but 
also  the  net  profits  from  operation  for  each  of  the  several  units 
of  which  the  business  may  be  composed.  These  separate  de- 
partmental revenue  statements  have  a  distinct  value,  and  may 
be  in  the  form  illustrated  on  the  following  page. 


MANAGERIAL  USE  OF   REVENUE   STATEMENT        151 


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152  ACCOUNTING  PRINCIPLES 

Where  condensed,  as  in  the  foregoing  illustration,  the  depart- 
mental revenue  statements  should  be  accompanied  by  special 
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even  if  the  business  is  not  organized  on  the  departmental  basis. 
With  a  knowledge  of  the  joint  expenses  required  to  sell  certain 
commodities,  it  is  possible  from  the  gross  profit  statement  to 
ascertain  whether  the  mark-up  is  sufficiently  high  for  the  vari- 
ous commodities  to  allow  for  the  expenses  estimated  to  be 
chargeable  to  them. 

7.  Purchases  and  Inventory.  —  Since  an  inventory  is  neces- 
ssury  for  closing  the  books  of  a  mercantile  business,  there  has' 
arisen  a  tendency  to  keep  a  record  of  purchases  at  cost,  to- 
gether with,  in  a  parallel  colimin,  a  record  of  the  sale  price  of 
the  goods  bought.  Under  such  an  arrangement,  the  purchase 
register  shows  not  only  the  total  of  merchandise  purchases,  but 
also  the  selling  price  which  is  placed  on  the  goods.  If  a  record 
is  further  kept  of  the  mark-down  as  well  as  of  the  mark-up,  it 
is  possible  to  approximate  the  merchandise  inventory  by  the 
use  of  an  average  percentage  of  the  mark-up,  the  individual 
percentages  being  of  course  certain  ratios  of  the  selling  price. 
A  weekly  departmental  stock  summary  may  be  kept  in  a  stock 
ledger  in  something  like  the  form  illustrated  on  the  following 
page. 

The  data  thus  summarized  in  the  stock  ledger  must  necessa- 
rily be  entered  in  detail  in  the  purchase  register;  otherwise  the 
weekly  totals  for  the  merchandise  stock  register  cannot  be  ob- 
tained. The  requirement  is  easily  provided  for  by  an  increase 
in  the  number  of  columns  in  the  purchase  register  to  include  a 
colunm  for  purchases,  sales,  mark-up  percentage,  and  reduc- 
tions. This  information  must,  of  course,  be  given  for  each 
commodity  or  group  of  commodities  for  which  accounts  are 
kept.    1  he  inventory  at  the  end  of  a  period  may  then  be  cal- 


MANAGERIAL  USE  OF  REVENUE   STATEMENT       153 


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154  ACCOUNTING  PRINCIPLES 

culated  by  means  of  the  following  formula,  which  is  derived  in 
the  manner  indicated: 

5"  =  Sales  during  the  p)eriod. 

R  =  Average  percentage  of  the  mark-up. 

D  =  Deductions  from  sales  through  price  reductions. 

C  =  Deductions  from  sales  through  discoimts. 

L  =  Sales  value  of  inventory  at  the  beginning  of  the  period 

plus  purchases  at  sales  price. 
N  =  Inventory  at  the  end  of  the  period  at  cost. 
Then  N=  {L-S-D-Q     {ioo-R)%. 

If  the  total  reductions  from  the  sales  inventory  at  the  begin- 
ning of  the  period  plus  purchases  at  sales  price  are  represented 

by  r, 

Then  T  =  S -\-  D -\- C 
And  AT  =  (L  -  J)  (loo-R). 

The  calculations  involved  in  the  application  of  this  formula 
are  made  in  the  illustration  given  above. 

There  should  be  a  test  of  the  calculated  inventory  not  less 
than  once  a  year.  If  the  calculated  inventor\'  is  used  as  indi- 
cated above,  the  inventory  count  should  show  both  the  pur- 
chase and  the  sales  price  of  the  goods  on  hand.  In  some  cases, 
the  inventory  is  taken  at  the  sales  price,  and  the  mark-up  per- 
centage used  to  calculate  an  inventory  at  cost,  but  this  method 
does  not  pro\ade  a  satisfactor>'  cost-price  inventory  to  be  used 
in  the  calculation  of  the  annual  profits. 

8.  Revenue  Item  Comparisons  and  Percentages.  —  It  does 
not  mean  much  to  a  busy  executive  to  tell  him  that  the  selling 
expenses  of  the  past  year  were  $1,500.00.  If,  however,  you  say 
that  the  selling  expenses  were  $1,500.00,  or  an  increase  of 
$500.00  over  the  selling  expenses  of  last  year,  while  the  profits 
from  sales  were  $500.00  less  this  year  than  the  year  before,  he 
gets  an  idea  of  the  course  of  affairs.  He  at  once  raises  the 
question  whether  the  increase  in  selling  expenses  does  not  rep- 
resent a  bad  investment,  resulting  in  a  reduction  of  profits.  To 
answer  this  question  correctly,  the  selling  expenses  must  be  ex- 
pressed as  a  percentage  of  the  total  sales.    If  it  is  found  that, 


MANAGERIAL  USE  OF  REVENUE  STATEMENT        155 

although  the  selling  expenses  for  the  past  year  were  $500.00 
larger  than  they  were  the  year  before,  they  were  at  the  same 
time  only  5  per  cent  of  the  total  sales,  whereas  in  the  preceding 
year  they  constituted  7  per  cent  of  the  total  sales,  the  executive 
must  look  elsewhere  than  to  the  selling  expenses  for  the  source 
of  the  reduction  in  the  profits.  In  other  words,  a  comparison 
of  one  year  with  another,  or  of  one  month  with  another,  can- 
not be  advantageously  made  unless  the  expenses  are  stated 
both  absolutely  and  relatively,  or  in  percentages  of  income. 
Expenses  are  justified  only  because  they  produce  income.  If 
increased  expenses  add  to  income  a  smaller  amount  than  the 
expense  increase,  the  surface  indications  are  that  the  addi- 
tional expense  is  not  justified  from  the  business  point  of  view. 
If  along  with  an  increase  in  expenses  there  develops  a  reduction 
in  the  ratio  of  expenses  to  income,  the  increased  expenses  seem 
amply  justified. 

The  condensed  departmental  comparative  statement  shown 
above  in  Illustration  No.  14  will  serve  as  a  condensed  compara- 
tive statement  for  two  years  of  operation  if  there  is  substituted 
for  the  column  Department  A  a  column  covering  the  business 
operations  for  the  past  year,  and  for  the  column  Department  B 
a  column  covering  the  operations  of  the  year  preceding  that  for 
which  the  statement  is  primarily  made.  If  the  statement  is  to 
be  made  for  the  year  ending  December  31,  1919,  the  caption  of 
the  column  headed  Department  A  becomes  Year  Ending  Decem- 
ber ji,  igig,  while  the  caption  of  the  column  headed  Depart- 
ment B  is  changed  to  read  Year  Ending  December  ji,  iqi8. 

The  form  of  statement  given  below  in  Illustration  No.  16  is 
designed  to  show  in  detail  an  analysis  of  the  data  as  found  in 
the  annual  closing  of  the  accounts,  and  is  used  where  the  busi- 
ness has  some  plan  for  cumulative  comparisons,  such  as  charts, 
and  wishes  a  full  statement  from  which  needed  data  may  be  se- 
lected. The  statement  shown  in  Illustration  No.  17  is  the  one 
which  would  prove  of  most  service  to  an  executive.  While 
there  are  no  percentages  except  the  percentages  of  increase  of 
each  item  as  compared  with  the  same  item  for  the  previous 
year,  these  percentages  are  very  useful  as  a  basis  for  compari- 


156  ACCOUNTING  PRINCIPLES 

sons.  If,  for  example,  there  is  a  20  per  cent  increase  in  income 
from  sales  and  a  15  per  cent  increase  in  operating  expenses,  the 
manager  is  able  to  draw  his  conclusions  much  more  quickly 
from  this  statement  than  from  Illustration  No,  14  above,  in 
which  the  percentages  are  given  in  parallel  colunms  and  must 
be  subtracted. 

In  the  form  of  comparative  statement  shown  below,  de- 
creases are  entered  in  red  in  the  increase  column. 

9.  Budgets  and  Statements.  —  The  statement  that  salaries 
and  wages  in  the  month  of  January  were  $15,000.00  does  not 
mean  a  great  deal  to  a  manager  unless  his  business  program 
has  been  carefully  analyzed  in  advance  and  it  has  been  deter- 
mined that  a  reasonable  allowance  for  salaries  and  wages  is, 
say,  $12,000.00.  The  statement  showing  a  larger  outlay  than 
was  anticipated  leads  to  analysis  for  the  purpose  of  finding  the 
causes  of  the  unexpectedly  large  total  of  expense.  The  fact 
that  expenditures  are  larger  than  they  were  for  the  correspond- 
ing month  last  year  would  lead  to  some  inquiry,  but  it  should 
be  possible  on  January  i  to  use  the  previous  experience  and  to 
forecast  the  current  situation,  so  that  a  close  estimate  could  be 
made  of  the  expenditures  to  be  anticipated.  This  estimate 
serves  as  a  standard  accomplishment  which  the  ofl&cers  and  em- 
ployees should  strive  to  attain.  It  is  becoming  more  customary 
in  business  to  estimate  for  each  succeeding  month  what  the  ex- 
pense and  incomes  are  to  be  for  the  month.  These  estimated 
incomes  and  expenses  may  be  combined  into  an  estimated  reve- 
nue statement  with  which  the  actual  revenue  statement  may 
be  compared  when  the  statement  for  the  month  is  made.  Illus- 
tration No.  17  shows  such  a  comparative  revenue  statement. 

The  estimated  expenditures  of  a  business  are  sometimes  re- 
ferred to  as  a  budget.  The  word  budget  has  been  more  gener- 
ally used  to  refer  to  classified  estimates  of  expenditures  for  a 
period  made  by  a  municipaUty  as  a  guide  to  the  discovery  of 
appropriations  required.  A  business  is  in  a  jx)sition  similar  to 
that  of  the  municipality  or  governmental  body.  Its  budget  of 
expenses  must  be  related  to  its  present  resources  and  its  ex- 
pected incomes.    The  budgetary  expenses  are  thus  related  to 


MANAGERIAL   USE   OF   REVENUE   STATEMENT       157 


the  incomes  in  the  estimated  or  anticipated  revenue  statement 
for  the  month  shown  in  Illustration  No.  17. 

In  large  business  concerns  the  expense  estimate  may  be  set 
up  on  the  journal  and  ledger  as  they  are  in  the  municipal  ac- 
counts. On  the  other  hand,  these  estimates  may  be  set  up  as 
comparative  statistical  data,  as  they  are  set  forth  in  Illustra- 
tion No.  21. 

ILLUSTRATION  NO.  16 

Pro  Forma  Revenue  Statement 

Revenue  Statement  for  Period  Beginning — Ended — ■ 

(All  Expense  Per  Cents  are  per  cents  of  Net  Sales;  Net  Profit 
per  cent  is  per  cent  of  Total  Capital.) 

Gross  Sales 

Less  Returns  and  Allowances 

Net  Sales 

Cost  of  Goods  Sold: 

Purchases 

Mdse.  Inv.  ist  of  Period 

Freight-In 

Total 

Less:  Purchase  Returns  and  Allow 

ances       

Mdse.  Inv.  End  of  Period 

Total  deductions 

Net  Cost  of  Goods  Sold      .     .     . 

Gross  Profits 

Expenses: 
Selling  Expenses: 

Salaries  and  Wages  of  Sales  Force 

Commissions  to  Sales  Force 

Traveling  Expenses  for  Sales  Force 

House  Entertainment 

Advertising 

Total 

Delivery  Expense: 

Operation  of  Auto  Truck 

Operation  of  Wagon  Truck  . 

Depreciation  of  Del.  Equipment 

Sundry  Delivery  Expense     . 

Total 


(%s). 


(%s) 


(%s) 


iS8 


ACCOUNTING  PRINCIPLES 


ILLUSTRATION  NO.   i6— Continued 
Revenue  Statement  for  Period  Beginning — Ended — Continued 


Management  and  Office: 

Stationery        .      

Salaries  of  Office  Force 

Office  Supplies      

Telephone  and  Telegraph     

Sundry  Office  Expenses 

Total (%s).... 

Maintenance,  Operation  and  Upkeep  Bldg. : 

Rent 

Heat,  Light  and  Power 

Taxes 

Insurance 

Repairs  of  Bldg.  and  Equipment     

Depreciation  of  Building       

Depreciation  of  Equipment 

Sundry  Expenses  of  Bldg 

Total (...%s) 

Losses  from  Bad  Debts       ....     {...%s) 

Miscellaneous  Expense        ....     (...%s) 

Total  Expense 

(...%s)     

Profits  from  Operation 

(...%s)     

Other  Income: 

Discount  on  Purchases    .... 

Interest      

Total  other  income 

Total  Income 

Deductions: 

Interest      

Discount  on  Sales 

Total 

Net  Profits 

(...%s)     

MANAGERIAL  USE  OF  REVENUE  STATEMENT         159 

ILLUSTRATION  NO.  17 
Comparative  Revenue  Statement 

Month  Month 

Estimated        ended  ended          Increase        Increase 

for            Dec.  31,  Dec.  31,                             percent 

Dec.,  1918          1918  1917 


r.  Net  Sales  Furniture 

2.  Cost  of  Fur.  Sales 

3.  Gross  Profit 

4.  Net  Sales  Carpets 

5.  Cost  of  Car.  Sales 

6.  Gross  Pro.  (Carpets) 

7.  Total  Gross  Profits 

8.  Selling  Expenses 

a.  Salaries  &  Wages 

b.  Commissions 

c.  Traveling  Exp. 

d.  House  Entertain- 

ment 

e.  Advertising 
Total  Selling  Exp. 

9.  Delivery  Expense 

a.  Operation     Auto 

Truck 

b.  O  p  e  r  .    Wagon 

Truck 

c.  Sundry- 
Total  Del.  Exp. 

10.  Management   and 
Office  Exp. 

a.  Stationery 

b.  Salaries 

c.  Office  Supplies 

d.  Tel.  and  Teleg. 

e.  Sundry 

Total  M.  &  O.  Exp. 


l6o  ACCOUNTING  PRINCIPLES 

ILLUSTRATION   NO.    17— Continued 
Comparative  Revenue  Statement — Continued 

Month  Month 

Estimated        ended  ended          Increase        Increase 

for             Dec.  31,  Dec.  31,                              percent 

,,   .    .                  ^               Dec.,  1918         1918  1917 

11.  Maintenance,  Opera- 

tion and   Upkeep 
of.  BIdg. 

a.  Rent  

b.  Heat,  Light  and 

Power  

c.  Taxes  

d.  Insurance  

e.  Repairs  

f.  Depreciation  

g.  Sundry  

Total  M.O.&U.  of  ~  " 

Bldg.  Exp.  

12.  Losses  from  Bad 

Debts  

13.  Misc.  Expenses  

14.  Total  9, 10,  II,  12, 13  

15.  Profit  from  Operation 

(7  minus  14)  

16.  Other  Income  

1 7.  Total  Income  

18.  Deductions  

19.  Net  Profit  

QUESTIONS  AND   PROBLEMS 

1.  What  is  the  managerial  use  of  an  account  payable?    An  account 
receivable?    A  delivery  expense  account?    A  fuel  account? 

2.  What  is  the  purpose  of  the  accounts  other  than  financial  accounts 
(accounts  receivable,  accounts  payable,  etc.)? 

3.  What  is  the  test  as  to  whether  any  particular  accounts  should  be  kept? 

4.  When  would  a  commodity  be  the  subject  of  an  account? 

5.  On  what  basis  are  accounts  grouped  in  a  revenue  statement? 

6.  What  has  the  organization  of  a  business  to  do  with  the  grouping  of 
accounts? 

7.  Of  what  managerial  advantage  has  the  group  of  fixed  costs? 

8.  What  makes  it  difficult  to  segregate  the  group  of  fixed  cost  accounts? 

9.  On  what  basis  are  incomes  groujaed  in  the  revenue  statement?     Why? 
10.     On  Januar>'  i,  1919,  the  merchandise  inventory'  was  $5,000.00.   The 

purchases  for  the  month  of  January  were  $4,000.00.  The  sales  were  $5,500.00. 
The  average  mark-up  was  40%  of  the  sale  price.  The  total  price  re- 
ductions for  the  month  were  $125.00.  What  was  the  inventory  at  the  end 
of  the  month? 


MANAGERIAL  USE  OF  REVENUE  STATEMENT        l6i 

11.  What  are  the  advantages  of  percentages  in  the  totals  of  accounts  or 
groups  of  accounts? 

12.  Discuss  the  uses  of  the  comparative  revenue  statement. 

Trial  Balance  of  King  Mdse.  Co.  for  Year  Ended  Dec.  31,  igig 

Cash  2,500.00 

Accounts  Receivable  4,500.00 

Mdse.  Inventory  21,000.00 

Delivery  Equipment  7,500.00 

Furniture  and  Fixtures  2,000.00 

Land  10,000.00 

Buildings  25,000.00 

Notes  Payable  8,900.00 

Accounts  Payable  5 ,000 .  00 

Mortgage  Payable  25,000.00 

John  King,  Capital  21,025.00 

Mdse.  Sales  75,000.00 

Return  Sales  and  Allowances  150.00 

Discount  on  Purchases  400 .  00 

Interest  Received  750.00 

Mdse.  Purchases  40,000.00 

Return  Purchases  200 .  00 

Administrative  Salaries  12,000.00 

Administrative  Expense-general  3,000.00 

Advertising  1,500.00 

Salaries  of  Salesmen  3,550.00 

Misc.  Selling  Expense  '                        850.00 

Operation  of  Delivery  Service  1,750.00 

Repairs  on  Delivery  Equipment  250.00 

Interest  Paid  350.00 

Discount  on  Sales  375.00 


136,275.00     136,275.00 


Adjustments,  Dec.  31,  1919. 

Mdse.  Inventory  25,000.00 

Salaries  of  Salesmen  accrued  200 .  00 

Interest  accrued  on  Notes  Payable  75  00 

Depreciation — ^4%  on  bldgs.,  7%  on  Del.  Equip.,  5%  on  Fur.  and 

Fixts. 

Reserve  for  Bad  Debts  125.00 

Deferrred  Expense — Advertising  250.00 

Deferred  Expense — Repairs  on  Delivery  Equipment  75- 00 

(a)  Journalize  the  adjusting  entries  and  close  through  the  journal,  open- 

ing all  accounts  on  the  ledger  which  are  involved  in  the  adjusting 
and  closing  entries. 

(b)  Make  out  a  Revenue  Statement  and  Balance  Sheet  in  due  form 


CHAPTER  XIII 
THE  FORM  AND  MANAGERIAL  USE  OF  THE  BALANCE  SHEET 

1.  Use  of  the  Balance  Sheet.  —  The  balance  sheet  is  highly 
essential  to  the  manager  in  arriving  at  the  standing  of  the  busi- 
ness at  the  close  of  the  fiscal  period  and  in  determining  changes 
in  the  financial  policy  of  the  concern  rendered  necessary  by  a 
comparison  of  the  condition  of  the  business  at  the  particular 
time  with  its  condition  at  the  close  of  previous  years.  While 
the  revenue  statement  provides  a  summary  of  operations  for 
the  years  and  of  their  result  in  net  profits,  the  balance  sheet  is 
needed  to  show  the  final  effect  of  these  operations  on  the  form 
and  amount  of  the  assets  and  liabilities.  Such  information  the 
manager  should  have,  and  the  creditors  of  the  concern  will  usu- 
ally require,  before  arranging  for  material  additions  to  the  in- 
ventory or  to  the  working  capital.  The  form  of  the  balance 
sheet  and  the  order  of  the  items  which  it  contains  become, 
therefore,  matters  deserving  of  consideration. 

2.  Kinds  of  Assets.  —  The  classes  of  assets  usually  found  in 
balance  sheets  are  as  follows:  (a)  Current  assets;  (b)  working 
assets;  (c)  investments  in  reserves;  (d)  permanent  investments; 
(e)  fixed  assets.  Current  assets  and  working  assets  are  tem- 
porary in  character.  The  first  class  (current  assets)  consists  of 
cash  and  of  other  items  which  are  turned  into  cash  from  month 
to  month  as  the  business  proceeds;  the  second  (working  assets) 
of  supplies  on  hand,  expenses  paid  in  advance,  advances  to 
agents,  etc.  While  it  is  true  that  some  of  the  working  assets 
may  be  converted  into  cash,  they  are  not  ordinarily  thus 
changed  in  the  regular  course  of  business.  Permanent  invest- 
ments consist  usually  of  interest  in  outside  ventures  maintained 
for  reasons  of  business  strategy,  and  may  be  composed  of  the 
securities  of  corporations  over  which  it  is  desired  to  exercise 
control  or  of  long-time  loans  to  allied  concerns  for  the  purpose 

162 


MANAGERIAL  USE   OF   BALANCE   SHEET  163 

of  gaining  a  degree  of  control  over  their  operations.  Fixed  as- 
sets are  the  investments  of  the  business  in  plant  and  other  per- 
manent property  essential  to  its  operation,  and  include  such 
items  as  land,  buildings,  furniture  and  fixtures,  machinery  and 
equipment,  goodwill,  patents,  and  franchises. 

In  considering  the  stability  of  a  business,  attention  must  be 
paid  to  the  readiness  with  which  the  various  assets  can  be 
turned  into  cash.  To  be  able  to  pay  obligations  from  funds  ac- 
cumulated from  the  regular  turnover  of  current  assets  is  not 
only  desirable  from  the  point  of  view  of  the  business  itself,  but 
is  particularly  desirable  from  the  standpoint  of  the  creditors  of 
the  concern.  The  latter  do  not  ordinarily  wish  to  collect  their 
bills  through  foreclosure  or  bankruptcy  proceedings.  The  in- 
terests of  both  the  business  and  its  creditors  require,  therefore, 
that  all  accounts  and  notes  currently  falling  due  shall  be  met 
from  current  assets  through  the  regular  turnover  accumulation 
of  cash  receipts. 

The  working  assets  may  be  partly  converted  into  cash,  and 
are  valuable  to  this  extent  in  case  liquidation  becomes  neces- 
sary. They  are  not  currently  turned  into  cash,  however,  with 
the  regular  turnover  of  the  merchandise  inventory. 

The  permanent  investments  may  or  may  not  be  readily  sala- 
ble, but  a  business  can  ill  afford  to  sell  them  to  liquidate  liabil- 
ities which  are  currently  falling  due.  On  the  other  hand,  they 
may  be  very  desirable  property  in  connection  with  a  liquida- 
tion of  all  the  assets,  frequently  bringing  an  amount  greatly  in 
excess  of  the  value  at  which  they  were  carried  on  the  books. 

The  fixed  assets  of  a  business  suffer  most  in  case  of  liquida- 
tion. They  are  primarily  valuable  as  part  of  a  going  concern, 
and  cannot  be  sold  to  advantage  when  separated  therefrom. 
They  frequently  form  the  basis  for  a  long-time  first  mortgage, 
the  holder  being  ordinarily  given  the  ranking  claim  against  the 
proceeds  arising  from  a  liquidation  of  the  mortgaged  assets. 

3.  Kinds  of  Liabilities  and  Proprietorship.  —  Liabilities  are 
classified  according  to  the  time  ordinarily  elapsing  before  they 
must  be  met.  The  classes  most  commonly  found  in  liability 
and   proprietorship   statements   are  as  follows:    (a)    Current 


1 64  ACCOUNTING  PRINCIPLES 

liabilities;  (b)  deferred  credits;  (c)  fixed  liabilities;  (d)  capital; 
(e)  appropriated  surplus;  (f)  surplus.  Current  liabilities  are 
obligations  which  mature  from  month  to  month  as  the 
regular  turnover  of  the  merchandise  stock  proceeds.  They 
are  in  effect  short-time  loans  to  the  business,  and  include 
such  items  as  notes  payable,  accounts  payable,  and  accrued 
accounts  payable.  The  last-named  item  is  sometimes  given  a 
special  heading,  such  as  accrued  liabilities  not  due.  Deferred 
credits  are  the  claims  of  a  succeeding  period  against  the  income 
received  by  the  business  during  the  period  covered  by  the 
balance  sheet.  They  are  not  liabilities,  however,  in  the  sense 
of  claims  that  must  be  paid.  They  represent  merely  profits 
received  in  advance  and  therefore  deferred  to  a  later  period. 
Fixed  liabilities  are  those  which  are  not  being  paid  from  month 
to  month  out  of  the  current  proceeds  of  sales,  such  as  bonds, 
five-year  notes,  etc.  Appropriated  surplus  is  a  group  of  accounts 
belonging  to  the  corporation  balance  sheet,  and  represents 
surplus  reserves  which  have  been  set  aside  for  special  purposes. 
The  surplus  invested  in  fixed  assets  is  sometimes  also  classed 
as  an  appropriated  surplus,  because  it  is  presumed  not  to 
be  subject  to  distribution  in  the  form  of  dividends.  As 
any  surplus,  however,  unless  specially  set  aside,  is  subject 
to  dividend  declarations,  regardless  of  the  business  asset  in 
which  it  may  be  invested,  the  better  practice  is  to  limit  the 
application  of  the  term  appropriated  surplus  to  surplus  funds 
which  have  been  created  and  are  being  held  for  designated 
purposes.  The  final  caption  of  the  liability  side  is,  of  course, 
the  capital  group  of  accounts.  In  the  partnership,  this  group 
consists  of  the  capital  accounts  of  all  the  partners;  in  the  cor- 
poration, of  the  various  classes  of  capital  and  of  the  regular  as 
well  as  the  appropriated  surplus. 

4.  Relation  of  Liabilities  to  Assets.  —  The  assets  of  a  busi- 
ness arise  only  through  the  creation  of  liabilities  and  pro- 
prietorship. If  two  or  more  partners  invest  a  certain  amount 
of  cash  each  in  a  business  venture,  the  firm  acquires  a  cash  asset 
of  the  total  amount  and  at  the  same  time  assumes  an  equal 
proprietary  obligation  to  the  owners  for  the  money  thus  con- 


MANAGERIAL   USE  OF   BALANCE   SHEET  165 

tributed.  If  goods  are  later  bought  on  credit,  a  liability  of 
accounts  payable  arises  to  compensate  for  the  asset  of  mer- 
chandise received.  Loans  from  a  bank  provide  an  asset  of  cash 
through  the  creation  of  notes  payable,  while  a  mortgage  of  the 
equities  of  the  owners  may  secure  still  other  assets  through 
the  setting  up  of  a  long-term  liability. 

In  acquiring  assets  through  the  creation  of  liabilities,  a  busi- 
ness usually  relies  upon  the  former  through  sale  or  operation 
to  provide  the  funds  with  which  the  latter  may  be  paid.  When 
accounts  payable  are  incurred,  it  is  expected  that  the  business 
will  be  able  to  pay  these  accounts  from  the  proceeds  of  the  sale 
of  the  goods  purchased  and  still  have  in  excess  of  the  purchase 
price  a  gross  profit  sufficient  to  yield  a  net  profit  after  expenses 
have  been  deducted.  For  the  fixed  or  service  assets,  which  or- 
dinarily remain  for  years  in  approximately  the  form  in  which 
they  are  installed  and  which  are  commonly  acquired  through 
the  creation  of  a  long-term  or  fixed  liability  or  through  the  is- 
suance of  capital  stock,  provision  must  be  made  for  retiring  any 
liabilities  outstanding  against  them  at  the  termination  of  their 
useful  life,  or  a  reserve  must  be  built  up  from  year  to  year  to 
equal  the  value  of  the  assets  by  the  time  they  are  used  up  and 
scrapped.  As  the  total  of  fixed  assets  is  ordinarily  maintained 
through  reserves  which  equal  or  exceed  the  depreciation  of 
these  assets,  it  is  unimportant  for  the  general  commercial  busi- 
ness to  undertake  to  make  the  fixed  liabilities  expire  with  the 
disappearance  of  the  original  assets  against  which  they  were  is- 
sued, because  new  assets  regularly  take  the  place  of  those 
which  are  discarded  and  the  total  of  these  assets  is  thus  main- 
tained. The  term  for  which  long-time  liabilities  are  issued, 
therefore,  becomes  more  a  question  of  the  demands  of  the  in- 
vestors to  whom  such  securities  may  be  sold.  A  business,  how- 
ever, whether  public  or  private,  which  does  not  provide  for  the 
depreciation  of  assets  through  the  creation  of  a  reserve  should 
make  the  term  of  the  liabilities  incurred  no  longer  than  the  use- 
ful life  of  the  assets  concerned;  otherwise,  the  business  will  be 
under  the  necessity  of  paying  a  return  for  the  use  of  assets 
which  it  no  longer  owns  in  addition  to  a  return  for  the  use  of 


1 66  ACCOUNTING  PRINCIPLES 

assets  still  in  operation.  Frequently,  where  the  business  is  a 
prosperous  one,  instead  of  providing  a  fund  for  the  retirement 
of  the  fixed  liabilities  as  they  fall  due,  the  owners  refund  the 
original  obligation  through  the  issuance  of  a  second  liability. 

Since  deferred  credits  are  essentially  an  apportionment  of 
revenues  to  a  future  period,  no  provision  is  necessary  for  their 
payment. 

The  capital  of  the  owners  of  a  business  represents  an  excess 
in  assets  over  the  amount  required  to  meet  the  definite  liabili- 
ties, and  an  increase  in  capital  an  increase  in  the  safety  of  these 
outside  claims.  Increases  in  capital  thus  have  a  tendency  to 
reassure  the  firm's  creditors  and  to  secure  for  the  business  a 
more  extensive  credit  than  would  otherwise  be  the  case.  The 
holders  of  current  liabilities  obviously  cannot  feel  safe  if  the 
total  of  their  claims  almost  equals  the  value  of  the  current  as- 
sets which  are  relied  upon  for  payment.  Consequenth^  where 
increases  of  capital  are  available  for  increasing  the  current  as- 
sets or  reducing  the  current  liabilities,  the  credit  standing  of 
the  business  is  materially  improved.  The  psychological  efifect 
of  such  increases  is  no  less  important  than  the  strictly  financial, 
for  in  the  case  of  a  thriving  business  the  total  current  assets 
reach  much  further  as  a  basis  for  credit  than  in  the  case  of  a 
business  in  which  the  net  profits  and  the  capital  balances  are 
on  the  decline. 

An  increase  in  the  surplus  of  a  corporation  has,  of  course,  the 
same  significance  with  reference  to  its  credit  standing  that  an 
increase  in  capital  has  with  respect  to  the  credit  standing  of  an 
individual  business  or  a  partnership.  Funds  derived  from  net 
profits  may  be  used  to  increase  the  current  assets,  the  working 
assets,  or  the  fixed  assets,  and  should  be  placed  where  they  will 
best  serve  as  an  effective  means  of  still  further  increasing  the 
net  profits,  except  in  so  far  as  they  may  be  required  for  distri- 
bution to  the  owners  of  the  business. 

There  is  a  special  significance  in  the  ratio  of  the  net  profits  of 
the  business  to  the  investment  of  the  owners.  This  ratio  rep- 
resents the  percentage  earned  on  the  capital,  and  according  as 
it  is  large  or  small  marks  the  success  or  failure  of  the  business 


MANAGERIAL  USE  OF  BALANCE  SHEET  167 

SO  far  as  the  interest  of  the  owners  is  concerned.  If  the  earn- 
ings are  greater  than  in  other  possible  lines,  the  owners  will  re- 
gard their  interest  as  a  profitable  investment  and  extend  the 
business  as  favorable  opportunities  present  themselves.  If,  on 
the  other  hand,  the  earnings  are  comparatively  low,  the  own- 
ers will  tend  to  contract  the  business  or  place  their  returns  in 
other  enterprises. 

5.  Comparative  Balance  Sheets.  —  A  comparison  of  balance 
sheets  furnishes  valuable  information  in  addition  to  that  of- 
fered by  an  analysis  of  the  individual  balance  sheets  under  con- 
sideration. The  effect  of  a  certain  line  of  business  policy  on 
the  financial  status  of  a  concern  cannot  be  fully  foreseen  nor 
can  it  be  fully  measured  except  by  comparing  the  balance  sheet 
items  as  they  existed  before  the  policy  was  inaugurated  with 
the  same  items  after  sufiicient  time  has  elapsed  for  the  policies 
in  question  to  accomplish  their  results.  If,  for  example,  a  busi- 
ness decides  to  discount  its  receivables  and  borrow  money  to 
be  in  a  position  to  take  advantage  of  its  own  purchase  dis- 
counts, this  policy  will  increase  notes  receivable  discounted  and 
decrease  accounts  payable,  or,  in  other  words,  lessen  the  total 
investment  in  current  assets  and  at  the  same  time  reduce  the 
current  liabilities.  Whether  the  results  of  such  .a  policy  are  a 
financial  advantage  is  best  determined  by  a  comparison  of  the 
balance  sheet  after  the  adoption  of  the  policy  with  the  balance 
sheet  before  it  was  initiated. 

Certain  tendencies,  moreover,  of  a  favorable  or  unfavorable 
nature  may  develop  in  connection  with  a  business,  growing 
largely  out  of  the  personal  characteristics  of  subordinate  execu- 
tives, changes  in  the  personnel  of  the  working  force,  or  circum- 
stances outside  the  business  itself,  and  not  in  accord  with  the 
general  business  program.  If  these  tendencies  are  to  be  quickly 
discovered,  there  must  be  frequent  comparisons  of  the  financial 
condition  of  the  business  with  its  condition  at  previous  clos- 
ings. Otherwise,  encroachments  on  current  assets  through 
their  investment  in  fixed  assets  may  gradually  result,  without 
a  full  realization  of  what  is  actually  taking  place. 

If  a  comprehensive  view  of  the  changes  occurring  in  a  given 


1 68  ACCOUNTING  PRINCIPLES 

period  is  desired,  this  can  be  had  by  first  determining  the  total 
increase  on  the  liability  side  and  then  analyzing  the  asset 
changes  to  ascertain  the  assets  in  which  the  additional  funds 
have  been  invested.  If  no  asset  has  been  decreased  in  the  in- 
terval, the  increase  in  the  liabilities  must  be  offset  by  a  corre- 
sponding increase  in  one  or  more  of  the  various  asset  items.  If 
some  asset  has  been  decreased,  manifestly  there  results  another 
source  from  which  the  increases  in  the  other  assets  may  have 
been  derived.  Conversely,  in  a  similar  manner,  the  total  in- 
crease on  the  asset  side  may  be  compared  with  the  increases  in 
the  several  liability  items  for  discovering  the  sources  from  which 
the  increase  in  the  assets  has  been  secured. 

Business  concerns,  like  other  institutions,  are  creatures  of 
growth,  and  the  measure  and  character  of  this  growth  during 
a  given  interval  are  best  studied  by  a  comparative  analysis  of 
the  balance  sheets  at  the  beginning  and  at  the  end  of  the 
period.  If  the  growth  is  to  be  considered  as  a  cumulative  mat- 
ter, it  is  necessary  to  go  even  further  than  this,  and  to  extend 
the  comparison  over  a  series  of  previous  balance  sheets.  Such 
studies  from  time  to  time  yield  valuable  information  bearing 
on  managerial  policy  which  cannot  otherwise  be  secured. 

6.  Comparison  of  Balance  Sheets  with  Estimates.  —  In  Chaj>- 
ter  XII,  it  was  pointed  out  that  a  well-managed  concern  usu- 
ally has  a  general  business  program  for  the  year  and  perhaps  a 
special  program  for  a  shorter  period  of  time.  Such  general  and 
special  programs  involve  the  setting  up,  not  only  of  an  esti- 
mated revenue  statement  for  the  period  covered,  but  also  of  an 
estimated  balance  sheet  at  its  close.  In  order  to  determine  the 
particulars  in  which  there  has  been  a  failure  to  accomplish 
what  was  planned,  this  estimated  balance  sheet  is  compared 
with  the  actual  balance  sheet  drawn  up  at  the  end  of  the  period 
under  consideration.  It  is  probably  not  often  that  a  business 
program  is  worked  out  in  sufficient  detail  to  include  a  complete 
estimated  balance  sheet,  being  more  frequently  limited  to  esti- 
mated sales,  estimated  purchases,  estimated  expenses,  and  esti- 
mated net  profits.  The  effect,  however,  of  the  business  opera- 
tions proposed  on  the  financial  status  of  the  concern  at  the  end 


MANAGERIAL  USE  OF  BALANCE  SHEET  169 

of  the  period  for  which  the  program  is  formulated  should  be  con- 
sidered in  order  to  control  properly  questions  of  business  policy. 
7.  Selection  of  the  Form  of  Balance  Sheet.  —  As  already  ex- 
plained, the  current  assets  and  current  liabilities  are  particu- 
larly important  in  the  determination  of  the  financial  problems 
of  a  mercantile  business.  They  are  of  importance  also  in  the 
case  of  a  railroad  or  of  a  manufacturing  concern.  The  greater 
part  of  railroad  financing,  however,  is  not  accomplished  through 
the  creation  of  current  liabilities,  generally  taking  the  form  of 
long-term  loans  or  of  funded  debts.  The  long-term  loans  are  in 
most  instances  mortgages  on  the  fixed  assets.  As  these  mort- 
gages are  brought  on  the  market,  the  prospective  purchasers  of 
the  securities,  in  order  to  arrive  at  the  safety  of  the  loan,  in- 
variably compare  the  total  assets  subject  to  the  mortgages  with 
the  total  long-term  liabilities  having  a  claim  against  the  assets 
in  question.  The  order  of  setting  up  the  assets  in  the  case  of  a 
railroad  is,  therefore,  ordinarily  opposite  to  that  commonly 
recommended  for  a  mercantile  concern.  The  fixed  assets  are 
listed  first,  the  other  assets  following  in  inverse  order.  Simi- 
larly, the  liabilities  are  set  up  with  capital  stock  first,  funded 
debt  second,  and  current  liabilities  third.  In  order  that  the 
difference  between  the  assets  and  the  liabilities  may  appear  in 
the  form  of  a  balance,  the  surplus  is  frequently  entered  last  on 
the  liability  side  of  the  corporation  balance  sheet.  As  an  illus- 
tration of  a  typical  balance  sheet  of  this  kind,  there  is  given  be- 
low the  balance  sheet  recommended  by  the  Interstate  Com- 
merce Commission  for  the  railroads  of  the  country. 

ILLUSTRATION  NO.  18 

Form  of  General  Balance  Sheet  Statement  as  Prescribed 

BY  the  Interstate  Commerce  Commission  for 

Steam  Roads 

Assets 
Property  Investment: 
Road  and  Equipment : 

Investment  to  June  30,  1907 
Investment  since  June  30,  1907 
Reserve  for  Accrued  Depreciation — Cr. 


I70  ACCOUNTING  PRINCIPLES 

Secvirities: 

Securities  of  Proprietary,  Affiliated,  and  Controlled  Companies  — 
Pledged 

Securities  Issued  or  Assumed  —  Pledged 

Securities  of  Proprietary,  Affiliated,  and  Controlled  Companies  — 
Unpledged 
Other  Investments: 

Advances  to  Proprietary,  Affiliated,  and  Controlled  Companies 
for  Construction,  Equipment,  and  Betterments. 
Miscellaneous  Investments: 

Physical  Property 

Securities  Pledged 

Securities  Unpledged 
Working  Assets: 
Cash 

Securities  Issued  or  Assumed  —  Held  in  Treasury 
Marketable  Securities 
Loans  and  Bills  Receivable 

Traffic  and  Car-Service  Balances  Due  from  Other  Comi>anies 
Net  Balance  Due  from  Agents  and  Conductors  > 

Miscellaneous  Accounts  Receivable 
Materials  and  Supplies 
Other  Working  Assets 
Accrued  Income  Not  Due: 

Unmatured  Interest,  Dividends,  and  Rents  Receivable 
Deferred  Debit  Items: 
Advances: 

Temporary  Advances  to  Proprietary,  Affiliated,  and  Controlled 
Companies 

Working  Funds 

Other  Advances 
Rents  and  Insurance  Paid  in  Advance 
Taxes  Paid  in  Advance 
Unextinguished  Discount  on  Securities: 

On  Capital  Stock 

On  Funded  Debt 

Prop>erty  Abandoned,  Chargeable  to  Operating  Expense 
Special  Deposits 

Cash  and  Securities  in  Sinking  and  Redemption  Funds 
Cash  and  Securities  in  Insurance  and  Other  Reserve  Fimds 
Cash  and  Securities  in  Provident  Funds 
Other  Deferred  Debit  Items 
Profit  and  Loss: 
Balance  (if  a  debit) 


MANAGERIAL  USE  OF  BALANCE   SHEET  171 

Liabilities 
Stock: 
Capital  Stock: 
Common  — 
Held  by  Company 
Not  Held  by  Company 
Preferred  — 
Held  by  Company 
Not  Held  by  Company 
Debenture  — 

Held  by  Company 
Not  Held  by  Company 
Receipts  Outstanding  for  Installments  Paid 
Stock  Liability  for  Conversion  of  Outstanding  Securities  of  Con- 
stituent Companies 
Premiums  Realized  on  Capital  Stock 
Mortgage,  Bonded,  and  Secured  Debt: 
Mortgage  Bonds — 
Held  by  Company 
Not  Held  by  Company 
Collateral  Trust  Bonds — 
Held  by  Company 
Not  Held  by  Company 
Plain  Bonds,  Debentures,  and  Notes — 
Held  by  Company 
Not  Held  by  Company 
Income  Bonds — 
Held  by  Company 
Not  Held  by  Company 
Equipment  Trust  Obligations  — 
Held  by  Company 
Not  Held  by  Company 
Miscellaneous  Funded  Obligations — 
Held  by  Company 
Not  Held  by  Company 
Receipts  Outstanding  for  Funded  Debt 
Receivers'  Certificates 

Obligations  for  Advances  Received  for  Construction,  Equipment, 
and  Betterments 
Working  Liabilities: 
Loans  and  Bills  Payable 

Traffic  and  Car-service  Balances  Due  to  Other  Companies 
Audited  Vouchers  and  Wages  Unpaid 
Miscellaneous  Accounts  Payable 


172  ACCOUNTING  PRINCIPLES 

Matured  Interest,  Dividends,  and  Rents  Unpaid 
Matured  Mortgage,  Bonded,  and  Secured  Debt  Unpaid 
Working  Advances  Due  to  Other  Companies 
Other  Working  Liabilities 
Accrued  Liabilities  Not  Due: 

Unmatured  Interest,  Dividends,  and  Rents  Payable 
Taxes  Accrued 

Deferred  Credit  Items: 

Unextinguished  Premiums  on  Outstanding  Fimded  Debt 
Op>erating  Reserves 

Liability  on  Account  of  Provident  Funds 
Other  Deferred  Credit  Items 
Appropriated  Surplus: 

Additions  to  Property  through  Income 
Resers'es  from  Income  or  Surplus: 

Invested  in  Sinking  and  Redemption  Funds 

Invested  in  Other  Reserve  Funds 

Not  Specifically  Invested 

Profit  and  Loss: 
Balance  (if  a  credit) 

8.  Relation  of  Form  of  Presentation  to  Problem  to  be  Solved. 
—  The  comparative  balance  sheet  has  been  especially  recom- 
mended for  managerial  use.  In  determining  the  form  of  it, 
however,  the  special  problem  to  be  solved  should  always  be 
considered.  If  the  manager  desires  to  compare  the  balance 
sheet  with  an  estimated  balance  sheet,  or  with  the  balance 
sheet  of  a  preceding  period,  the  form  shown  in  Illustration  Xo. 
20  below  should  be  used.  On  the  other  hand,  a  banker  is  ordi- 
narily satisfied  by  a  revenue  statement  and  a  balance  sheet 
without  detailed  comparisons,  the  single  statement  indicating 
the  strength  or  weakness  of  the  business.  For  the  banker's 
purpose,  therefore,  the  forms  shown  in  Illustration  Xo.  21  and 
Illustration  Xo.  16  are  sufficient.  An  accountant  ordinarily 
makes  out  a  combined  revenue  statement  and  balance  sheet 
for  the  period  under  consideration  before  throwing  the  infor- 
mation into  the  form  of  a  comparative  revenue  statement  and 
comparative  balance  sheet. 

9.  Importance  of  Revenue  Statement  and  Balance  Sheet.  — 
The  accounting  information  found  in  the  regular  books  of  rec- 


MANAGERIAL  USE  OF  BALANCE  SHEET  173 

ord  is  largely  a  sealed  book  for  many  business  executives,  the 
facts  being  couched  in  a  language  unintelligible  to  those  who 
do  not  understand  the  form  and  interpretation  of  accounts.  A 
trial  balance  conveys  an  interesting  story  to  an  accountant,  but 
may  be  entirely  without  value  to  an  executive.  As  a  large  part 
of  the  information  upon  which  business  policies  are  based  is 
contained  in  the  accounting  records,  it  is  of  the  greatest  impor- 
tance that  this  information  should  be  so  formulated  as  to  con- 
vey to  the  manager  the  data  which  he  needs  in  the  solution  of 
the  problems  that  confront  him.  The  accountant  must  conse- 
quently be  informed  in  regard  to  these  problems,  so  that  he 
may  be  guided  thereby  in  determining  the  form  in  which  re- 
ports shall  be  made.  Frequently,  in  addition  to  comparative 
data  properly  arranged,  a  full  discussion  of  the  figures  by  the 
accountant  is  extremely  desirable,  in  order  to  give  to  the  execu- 
tive a  more  complete  idea  of  the  significance  of  the  information 
conveyed  in  the  report. 

10.  The  Cash  Estimate  and  the  Budget.  —  Expenses,  pur- 
chases, and  short-time  liabilities  are  generally  liquidated  in 
cash.  A  liability  is  sometimes  met  by  the  issue  of  another  lia- 
bility. This  serves  to  postpone  the  day  when  the  outlay  of 
cash  is  to  be  made  in  an  amount  equal  to  the  liability.  A 
company  with  ample  assets  may  become  insolvent  because  of 
its  inability  to  sell  these  assets  for  cash  in  time  to  pay  certain 
liabilities  falling  due.  The  assets  are  worth  the  amount  of  the 
liability  provided  it  was  not  necessary  to  sell  quickly.  At  a 
sacrifice  sale  they  may  not  be  sufficient  to  meet  the  liabilities. 
If  the  holder  of  liability  claims  becomes  insistent,  the  business 
may  become  insolvent  and  the  proprietors  may  lose  their  entire 
claims  in  the  sacrifice  sale.  It  is,  therefore,  important  to  esti- 
mate the  cash  requirements  of  a  business  and  also  the  sources 
from  which  the  cash  may  be  received,  in  order  to  be  in  a  posi- 
tion to  make  provision  for  financing  the  business  operations. 
Such  a  financing  program  for  a  period  of  six  months  would  in- 
volve listing  the  amounts  of  cash  receipts  expected  from  various 
sources  by  months  and  listing  opposite  the  cash  requirements. 
Such  a  schedule  might  be  made  in  the  following  form: 


174 


ACCOUNTING  PRINCIPLES 


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MANAGERIAL  USE  OF  BALANCE  SHEET 


175 


The  preparation  of  a  form  of  expected  cash  receipts  and  dis- 
bursements would  require  a  careful  analysis  of  both  the  bal- 
ance sheet  and  revenue  statement. 


ILLUSTRATION  NO.  20 

Valley  Furniture  Company 

Comparative  Balance  Sheet,  December  31 
(The  per  cents  other  than  increase  per  cents  are  of  total  assets  or  total 

liabilities) 


Current  Assets: 

Cash 

Notes  Receivable     . 
Accounts  Receivable 
Mdse.  Inventory 
Accrued  Inc.  Not  Due: 

Interest 

Rent     .... 
Total        .... 


Working  Assets: 

Supplies  Inventory  . 
Deferred  Expense: 

Insurance  . 

Ext.  Repairs   . 
Advances  to  Agents 
Total        .      .     .     . 


Investment  of  Reserves: 
Bond  Sinking  Fund 
Replacement  Fund  . 
Total        .... 


Permanent  Investments: 

Securities  in  A.  B.  C.  Co. 

Advances  to  G.  H.  Co. . 

Total 

Fixed  Assets: 

Land 

Buildings 

Furniture  and  Fixtures 

Plant        .... 

Equipment    . 

Goodwill 

Totals      .... 
Grand  Total  Assets     . 


Assets 

1918  1917        Increases 


Inc.  % 


(- 

%).... 

(-%) 

(- 

%).... 

(-%) 

(- 

%).... 

(-%) 

(- 

%).... 

(-%) 

(- 

%).... 

(-%) 



176 


ACCOUNTING  PRINCIPLES 


Current  Liabilities: 

Notes  Payable 

Accounts  Payable 

Accrued  Accounts  Payable: 

Interest 

Rent 

Taxes 

Totals (— %r 

Deferred  Income: 
Royalties  . 
Rent     .... 
Total    .... 
Fixed  Liabilities: 
Bonds       .... 
Mortgages 
Notes  (Long-term) 
Totals      .... 
*Capitals: 
A's  Capital    . 
B's  Capital    . 
C's  Capital    .     .     . 
Total        .... 
Grand  Total  Liabilities 


Liabilities  and  Proprietorship 
1918  1917 


(-%).. 


(-%). 


(-%).. 


(-%)... 


(-%) 


(-%) 


(-^^f).. 


(-%). 


[ncrea 

Lses 

rnc.  % 

ILLUSTRATION  NO.  21 

Account  Form  of  Balance  Sheet 

Valley  Furniture  Company 

Balance  Sheet,  December  31,  191 8 

(The  per  cents  are  of  total  assets  or  total  liabilities) 


Assets 
Current: 

Cash 

Notes  Receivable 
Accounts  Receivable 

Mdse.  Inventorj- 

Accrued  Income  Not  Due: 

Interest       

Rent       

Total    .      .     . 


Liabilities  and  Proprietorship 
Current  Liabilities: 

Notes  Payable     

Accounts  Payable     

Accrued  Accounts  Pay. : 

Interest       

Rent      

Taxes     ....     

Total (—%)... 


.(-%). 


*  For  a  corporation  this  section  would  be  as  follows 
Capital:  iqiS 

Capital  Stock  Common  . 
Capital  Stock  Preferred 
Appropriated  Surplus 

Surplus 

Total (— %) {^^%V. 


Inc. 


Inc.  % 


MANAGERIAL  USE  OF  BALANCE  SHEET 


177 


Permanent  Investments: 

Securities  in  A.  B.  C.  Co 

Advances  to  G.  H.  Co 

Total (— ■%) 


Deferred  Income: 

Working  Assets:  Royalties 

Supplies  Inventory    Rent 

Deferred  Expense:  Total (— %). 

Insurance    

Ext.  Repairs     Fixed  Liabilities: 

Advertismg       B^^^^ 

Advances  to  Agents  .      Mortgages      

Total (— %) Notes  (Long-term)    

Total (-^ 

Investment  of  Reserves: 

Bond  Sinking  Fund *Capital- 

Replacement  Fund    .      A's  Capital 

Total (— %) B's  Capital 

C's  Capital 

Total   .      .  . 


.(-%) 


Fixed  Assets: 

Land 

Buildings  .... 
Furniture  and  Fixtures 

Plant 

Equipment 

Good  will  .... 


Total    .      . 
Grand  Total. 


.(-%). 


Grand  Total 


QUESTIONS  AND  PROBLEMS 

1.  What  are  the  purposes  of  the  balance  sheet? 

2.  Why  does  a  creditor  wish  to  see  the  balance  sheet? 

3.  What  are  the  classes  of  assets  ordinarily  found  in  the  balance  sheet? 

4.  Define  each  of  the  classes  of  assets  and  discuss  the  difference  between 
the  several  classes. 

5.  What  are  the  different  kinds  of  liabilities"^ 

6.  Define  each  class  of  liabilities  and  discuss  the  basis  of  the  classification. 

7.  Indicate  the  various  ways  in  which  assets  are  secured  through  the 
creation  of  liabilities  or  proprietorship. 

*  For  a  corporation  this  section  would  be  as  follows: 
Capital: 

Capital  Stock  Convmon 
Capital  Stock  Preferred 
Appropriated  Surplus   . 

Surplus 

Total      ; (— %) 


178  ACCOUNTING  PRINCIPLES 

8.  Upon  what  assets  does  a  business  ordinarih'  rely  for  funds  to  meet  the 
several  classes  of  liabilities  as  they  fall  due? 

Q.  To  what  other  class  of  liabilities  are  deferred  credits  similar  in  their 
nature?  To  what  class  of  creditors  would  the  property  or  funds  reserved 
by  the  creation  of  deferred  credits  finally  be  apportioned  in  the  case  of  a 
successful  dividend  producing  property? 

10.  How  would  the  balance  sheet  be  used  by  a  prosf>ective  creditor  for 
the  purpose  of  determining  the  advisability  of  an  additional  extension  of 
credit  for  the  purchase  of  more  merchandise? 

11.  How  would  the  balance  sheet  be  used  by  a  bank  in  determining 
whether  it  should  extend  short-time  loans  to  be  invested  in  current  assets 
and  working  assets? 

12.  What  are  net  current  assets,  and  what  is  their  significance  to 
creditors  in  determining  the  advisability  of  granting  a  request  for  additional 
loans? 

13.  What  useful  information  may  a  manager  secure  from  the  comjjarative 
balance  sheet  in  the  determination  of  financial  policy? 

14.  How  often  should  the  manager  require  a  balance  sheet?    Why? 

15.  WTiat  factors  have  a  bearing  on  the  question  of  the  order  in  which 
the  respective  groups  of  assets  should  be  placed  in  the  balance  sheet? 

16.  WTiy  might  it  be  more  desirable  to  have  a  railroad  balance  sheet 
with  the  fixed  property  investments  and  permanent  liabilities  listed  first? 

17.  What  factors  have  a  bearing  on  the  determination  of  the  order  in 
which  items  should  be  listed  in  the  balance  sheet? 

18.  Make  the  necessarj'  arrangements  and  corrections  to  place  the  fol- 
lowing comparative  revenue  statement  and  balance  sheet  in  the  best  form: 


THE  NATIONAL  FARM  MACHINERY  COMPANY 

Revenue  Statement 

1918  1919 

Har\'esting  machinery,  tillage  instruments  and 
twine: 

United  States  34,616,559      37,730,448 

Foreign  Countries  22,894,797      25,202,914 

Total  57.511.356      62,933,362 

Wagons,    manure    spreaders,    gasoline    engines, 

cream  separators,  auto  wagons,  tractors: 

United  States  15,480,607      18,772,535 

Foreign  Countries  5.239,578        8,993,142 

Total  20,720,185      27,765,677 

Stool  Products,  fibre  sales,  etc.:  8,383,068      10,467,320 

Total  Sales  86,614,549    101,166,359 

Miscellaneous  Earnings  and  Charges  869,767           828,529 

Total  Income  87,484,316    101,994,888 


MANAGERIAL  USE  OF  BALANCE  SHEET  179 

Deductions:                                                              1918  1919 
Cost  of  Manufacturing  and  Distributing                    64,950,314  76,641,370 
Ordinary  Repairs  and  Maintenance                              2,244,404  2,911,945 
Experimental,  Development  and  Patent  Expenses         474.515  5^7.933 
Administrative  and  General  Expenses                             589.753  610,883 
Interest  on  Loans                                                               558,056  1,003,981 
Appropriations  for  Fire  Insurance  Fund                          250,000  250,000 
Appropriations  for  renewals  and  minor  improve- 
ments                                                                           567.152  575.000 
Reserve  for  Pension  Fund                                                 250,000  250,000 
Reserve  for  Industrial  Accident  Fund  250,000 
Reserx'C  for  plant  depreciation  and  ore  extinguish- 
ment                                                                         1,827,382  1,848,957 
Reserve  for  contingent  losses  and  collection  ex- 
penses on  receipts                                                     880,000  1,000,000 
Total  Deductions                                             72,591,576  85,910,069 
Net  Profit                                                        14,892,740  16,084,819 
Preferred  Dividends                                            4,200,000  4,200,000 

Common  Dividends                                            3,200,000 

4,200,000  7,400,000 

Balance  of  undivided  profits                                         10,692,740  8,684,819 

NATIONAL  FARM  MACHINERY  COMPANY 

Combined  Statement  of  Profits 
1909-1910 

Balance  Sheet,  December  30 

1909  1910 


Current  Assets: 

Raw     Materials     and 

Products 

S3.399.926 

61,646,43s 

Notes  Receivable 

46,212,036 

55,506,547 

Cash 

5,426,600 

105,038,652 

4.561,171 

121,714,153 

Current  Liabilities: 

Bills  Payable 

5,824,750 

13,778,045. 

Accrued  Payables 

5,090,531 

7,913,112 

Purchase  Money 

Obligations 

2,250,000 

1,125,000 

Dividends  Payable 

1,050,000 

14.215,128 

1,050,000 

23,866,157 

Net  Current  Assets 

90,823,371 

97,847,996 

Fixed  Assets: 

Real  Estate,  Plant,  etc. 

66,532,609 

71,887,402 

Insurance  Fund  Assets 

1,070,862 

1,514.313 

Advance  Payments  on 

Royalties 

153,419 

67,766,890 

190,215 

73,591,930 

l8o  ACCOUNTING  PRINCIPLES 


Fixed    Assets    plus    Net                             IQOQ 

1910 

Current  Assets:                               158,580,261 

171.439.926 

Capital  Stock: 

Prfd.  Stock                    60,000,000 

60,000,000 

Preferred  Stock             60,000,000 

60,000,000 

Common                         60,000,000 

80,000,000 

Misc.  Reserves              11,195,531  131,195,531 

14,540,377 

154,540,377 

Surplus                                                      27,384,73c 

16,899,549 

19.  Trial  Balance  of  King  Mdse.  Co. 

For  Year  Ended  December  3 

III  1920 

Cash       - 

$2,000.00 

Accounts  Receivable 

18,250.00 

Reserve  for  Bad  Debts 

$125.00 

Mdse.  Inventory 

15,000.00 

Delivery  Equipment 

7,500.00 

Delivery  Equipment  Depreciation  Reserve 

52500 

Furniture  and  Fixtures  —  Depreciation  Reserve 

lOO.OO 

Furniture  and  Fixtures 

2,500.00 

Land 

10,000.00 

Building 

25,000.00 

Building  —  Depreciation  Reserve 

1,000.00 

Notes  Payable 

9,000.00 

Accounts  Payable 

7,500.00 

-^^^ortgage  Payable 

25,000.00 

John  King,  Capital 

26,800.00 

Merchandise  Sales 

100,000.00 

Return  Sales  and  .Mlowances 

300.00 

Interest  Received 

475  00 

Merchandise  Purchases 

63,000.00 

Return  Purchases 

425.0® 

Administration  Salaries 

12,700.00 

.Administration  Exjxjnse  —  general 

3,500.00 

Advertising 

2,500.00 

Salaries  of  Salesmen 

4,750.00 

Miscellaneous  Selling  Expenses 

750.00 

Operation  of  Deliver>'  Service 

1,950.00 

Repairs  on  Delivery  Equipment 

350.00 

Interest  Paid 

400.00 

Discount  on  Sales 

500.00 

$170.950.00  $170,950.00 

Adjusting  Entries,  December  31,  1920 

Merchandise  Inventory  18,500.00 

Bonus  to  Salesmen  allowed  on  year's  service  475 .00 
Deferred  Expense  Items: 

Operation  of  Delivery' Service  125.00 

Repairs  on  Delivery  Equipment  350.00 


MANAGERIAL   USE  OF   BALANCE   SHEET  l8l 

Accrued  Accounts  Payable: 
.Interest  i3S-oo 

Salesmen's  Salaries  525.00 

Depreciation  Allowed: 

4%  on  Buildings,  7%  on  Delivery  Equipment,  5%  on  Furniture 
and  Fixtures 
Deferred  Expense  Items: 
Advertising  400 .  00 

Repairs  on  Delivery  Equipment  85 .  00 

(a)  Journalize  the  adjusting  and  closing  entries  as  at  the  close  of  1919. 

(b)  Make  comparative  revenue  statement,  taking  the  figures  from  the  pre- 

ceding chapter  for  1919. 

(c)  Comment  on  the  explanation  of  the  increases  in  revenue  items  in  so  far 

as  any  inference  can  be  drawn. 


CHAPTER  XIV 

INTERNAL   ANALYSIS   OF  BALANCE   SHEET   AND   REVENUE 
STATEMENT 

1.  Method  of  Internal  Analysis.  —  In  the  preceding  chapter 
conclusions  were,  in  general,  drawn  from  a  comparison  of  cer- 
tain items  of  the  revenue  statement  as  shown  in  the  report  of  a 
given  year  with  the  similar  items  shown  in  a  report  of  a  corre- 
sponding preceding  year.  This  method  of  comparison  is  of 
value  in  determining  to  what  extent  a  business  is  making  im- 
provement from  period  to  period  over  its  results  as  shown  by 
preceding  periods.  It  is  possible,  however,  to  construct  certain 
ratios  and  certain  comparisons  in  the  case  of  a  balance  sheet 
that  are  significant  from  a  credit  point  of  view  and  from  a 
point  of  view  of  the  condition  of  the  business,  by  comparison 
of  certain  items  of  the  periodical  report  with  certain  other 
items  for  the  same  period. 

For  example,  if  the  net  worth  of  a  business  as  shown  by  the 
balance  sheet  has  a  ratio  to  the  total  of  fixed  assets  equal  to 
one,  this  indicates  that  the  proprietors  have  themselves  in- 
vested an  amount  in  the  business  equal  to  the  total  investment 
in  fixed  assets.  Of  course,  further  analysis  could  be  made  by 
deducting  from  fixed  assets  the  net  worth  for  the  purpose  of 
showing  the  amount  of  proprietary  investment  in  current  as- 
sets. This  amount  could  likewise  be  reduced  to  percentage, 
showing  the  per  cent  of  current  assets  provided  for  by  the  in- 
vestment of  the  proprietors.  Likewise,  the  ratio  of  the  net 
sales  of  a  business  to  the  accounts  receivable  at  a  particular 
date  would  have  a  distinct  value  in  indicating  the  readiness  of 
collection  of  the  proceeds  of  sales.  If  the  ratio  is  very  high,  say 
500%,  this  would  indicate  that  one  fifth  of  the  sales  for  the 
period  were  not  collected  at  the  end  of  the  period.  If  the  period 
were  a  year  and  the  sales  were  credit  sales,  one  would  judge 
that  accounts  on  an  average  ran  something  over  sixty  days. 

182 


INTERNAL  ANALYSIS  OF  BALANCE  SHEET  183 

If  the  percentage  of  sales  were  over  1000,  as  is  the  case  in  the 
packing  industry,  and  sales  were,  in  general,  made  on  time, 
this  would  indicate  that  accounts  receivable  on  an  average  run 
between  thirty  and  sixty  days. 

If  the  ratio  of  sales  for  a  year  to  the  average  merchandise  in- 
ventory at  sale  price  be  high,  this  would  indicate  that  there  is 
a  rapid  turnover  of  goods,  and  that  consequently  a  business 
man  could  afford  to  lend  money  for  the  purchase  of  such  mer- 
chandise, because  of  its  ready  conversion  into  cash.  At  the 
same  time,  however,  a  low  ratio  of  sales  to  receivables  would 
indicate  slow  collections  and  would  tend  to  make  a  given 
amount  of  merchandise  stand  for  a  smaller  amount  of  credit. 

If  in  any  particular  business  the  ratio  of  sales  to  net  worth 
were  high,  this  would  indicate  a  low  investment  on  the  part  of 
the  proprietors,  considering  the  volume  of  sales,  and  in  case  the 
ratio  of  net  worth  to  fixed  assets  is  at  the  same  time  low,  a  sat- 
isfactory profit  could  be  made  by  a  small  differential  on  each 
unit  of  goods  sold.  The  business  would  also  tend  to  be  satis- 
factory from  the  standpoint  of  commercial  credit  advances. 
The  ratio  of  total  liabilities  to  net  worth  in  terms  of  per  cent  in- 
dicates the  comparative  amount  of  investment  by  the  propri- 
etors in  contrast  to  that  of  outside  parties. 

2.  A  Comparison  of  Ratios  for  Various  Industries.  —  A  list 
of  industries  will  be  found  in  the  table  below  ranked  according 
to  the  ratio  of  current  assets  to  current  liabilities.  This  ratio 
is  sometimes  spoken  of  as  the  current  ratio.  It  is  high  in  the 
case  of  farm  implements.  It  is  not  safe  in  such  an  industry 
where  collections  are  comparatively  slow  that  current  liabilities 
shall  be  so  high  as  compared  with  current  assets  as  they  are  in 
other  industries  more  favorably  situated  in  this  respect.  It  is 
found  that  the  current  ratio  is  low  in  the  case  of  the  packing 
industry.  Current  liabilities  can  be  very  high  as  compared 
with  current  assets  in  the  packing  industry  because  there  is  a 
rapid  turnover  and  also  ready  collections.  This  rapid  turnover 
will  also  be  found  to  exist  in  the  case  of  the  packing  industry 
as  compared  with  other  industries  by  reference  to  the  sales- 
merchandise  inventory  column  in  the  table  below.     On  the 


1 84  ACCOUNTING  PRINCIPLES 

Other  hand,  this  ratio  is  very  low  in  the  case  of  the  farm  imple- 
ment busmess.  In  the  table  below  it  is  generally  true  that  if 
the  current  ratio  is  low  the  turnover  or  sales-merchandise  in- 
ventory ratio  will  be  high.  It  would  further  tend  to  be  true 
that  the  ratio  of  sales  to  receivables  in  such  cases  will  also  be 
high.  The  table  below  showing  these  various  ratios  was  con- 
structed from  data  furnished  by  Alexander  Wall  and  puTslished 
in  the  Federal  Reserve  Bulletin  for  March  i,  1919,  page  243. 
See  Table  A  on  opposite  page. 

3.  Ratios  and  Comparison  of  Periods.  —  While  the  percent- 
ages described  in  Table  A  have  particular  value  for  the  purpose 
of  determining  the  credit  standing  of  a  business,  they  also  have 
value  from  a  managerial  point  of  view.  If  a  banker  or  creditor 
has  apprehension  concerning  the  prosperity  and  financial  sta- 
bility of  a  business,  the  managers  themselves  should  take  pre- 
cautions so  to  improve  the  afifairs  of  the  business  that  it  will 
command  confidence  and  show  a  more  prosperous  condition. 

Table  A  illustrates  one  of  the  methods  of  setting  standards 
for  the  relative  status  of  various  items  in  the  periodic  reports  of 
a  business.  If  it  is  found  that  the  average  status  of  items  for 
widely  distributed  prosperous  concerns  show  certain  percent- 
ages and  relations,  one  is  justified  in  raising  questions  in  regard 
to  the  advisability  of  a  set  of  ratios  for  his  own  business  vary- 
ing widely  from  those  commonly  found. 

It  may  not  be  feasible  to  change  the  status  of  various  items  sud- 
denly. The  comparative  report  shows  the  progress  being  made 
from  period  to  period  iri  improving  the  standing  of  a  business. 

4.  Ratios  Representing  Prosperity.  —  One  of  the  ratios  com- 
monly used  to  indicate  the  degree  of  the  prosperity  of  a  busi- 
ness is  not  found  in  Table  A.  The  ratio  of  net  profits  to  net 
worth  indicates  the  percentage  of  earnings  which  the  business 
yields  to  the  proprietors.  If  this  percentage  is  increasing  from 
year  to  year  it  is  the  best  possible  proof  of  successful  manage- 
ment. But  one  of  the  chief  methods  of  running  up  this  ratio  is 
to  increase  the  column  of  ratio  of  sales  to  merchandise.  The 
manager  should  see  to  it  that  the  business  does  not  carry  a  su- 
perfluous stock  of  any  item  of  merchandise  considering  such 


INTERNAL  ANALYSIS  OF  BALANCE  SHEET 


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1 86  ACCOUNTING   PRINCIPLES 

factors  as  time  required  to  replenish  stock  and  economy  of 
quarterly  orders.  An  attempt  to  increase  the  ratio  of  sales  to 
merchandise  inventory  will  require  some  standardized  program 
of  maximum  and  minimum  of  stock  to  be  carried  in  the  various 
lines  of  merchandise  and  supplies. 

An  improvement  in  the  collection  program  might  decrease  the 
ratio  of  receivables  to  merchandise  and  thus  improve  the  credit 
position  of  a  company  and  decrease  the  losses  from  bad  debts. 

One  of  the  reasons  for  receiverships  and  bankruptcies  lies  in 
the  fact  that  the  ratio  of  debt  or  liabilities  to  net  worth  is  un- 
reasonably high.  The  remedy  lies  in  a  larger  proprietary  in- 
vestment. When  a  receivership  occurs  for  this  reason,  a  reor- 
ganization should  set  up  a  balance  sheet  showing  a  smaller 
ratio  of  liabilities  to  net  worth. 

In  Mr.  Wall's  studies  these  ratios  were  also  compiled  by  sec- 
tions of  the  country  as  well  as  by  industries.  The  value  of  the 
whole  study,  however,  lies  more  in  the  method  than  in  the  re- 
sults, although  the  results  themselves  might  be  taken  subject  to 
corrections  and  further  modification  to  be  made  on  the  basis 
of  a  study  of  the  particular  problems  of  the  given  business. 

5.  Limitations  of  Statistical  Analysis.  —  Accounting  statis- 
tics never  tell  the  whole  story  in  regard  to  the  credit  position  or 
even  the  future  prospects  of  a  business  concern.  The  experi- 
ence, character,  and  intelligence  of  the  manager  are  always  of 
great  importance.  Moreover,  the  character  of  employees,  local 
competition,  and  the  general  business  situation  are  all  matters 
of  consequence  in  gauging  the  future  prospects  of  an  enter- 
prise. 

QUESTIONS  AND  PROBLEMS 

1.  What  is  the  use  of  the  ratio  of  net  profits  to  proprietary  investment, 
expressed  in  per  cent? 

2.  Define  and  disoiss  the  use  of  each  of  the  eight  ratios  discussed  in  the 
text. 

3.  What  facts  outside  statistical  analysis  are  important  in  gauging  the 
credit  and  future  prosperity  of  a  business? 

4.  Presuming  the  John  Smith  business  referred  to  in  the  Questions  and 
Problems  at  the  end  of  the  two  preceding  chapters  to  be  a  dry-  goods  busi- 
ness, discuss  its  peculiarities  and  analyze  the  credit  position  and  prospects 
of  the  enterprise. 


CHAPTER  XV 
CONTROLLING  ACCOUNTS  AND   COLUMNAR  BOOKS 

I.  The  Nature  of  a  Controlling  Account.  —  If  all  customer 
accounts  and  all  creditor  accounts  were  kept  in  the  general 
ledger,  it  would  become  a  very  large  and  unwieldy  book  in  the 
case  of  a  large  business.  It  is  customary,  therefore,  to  elimi- 
nate from  the  general  ledger  all  detail  customer  accounts  and 
all  detail  creditor  accounts,  and  to  insert  in  their  stead  a  gen- 
eral controlling  account  for  customers  and  a  general  controlling 
account  for  creditors.  The  detail  customer  accounts  are  then  kept 
in  what  is  called  the  sales  ledger  and  the  detail  creditor  accounts 
are  kept  in  what  is  called  the  purchase  ledger  or  creditors' 
ledger.  These  customer  accounts  are  then  represented  in  the 
general  ledger  only  in  totals.  The  controlling  account  for  the 
customers'  ledger  would  be  called  accounts  receivable  and  the 
controlling  account  for  the  purchase  ledger  would  be  called  ac- 
counts payable.  There  would  be  charged  to  the  accounts  re- 
ceivable controlling  account  in  total  all  of  the  charges  which 
are  made  in  detail  to  the  individual  customer  accounts.  Like- 
wise, there  would  be  credited  to  the  accounts  receivable  account 
the  total  of  all  credits  which  are  made  in  detail  to  the  individ- 
ual customer  accounts.  It  is  clear  then  that  the  balance  of  the 
accounts  receivable  controlling  account  would  be  equal  to  the 
sum  of  the  balances  of  the  individual  customer  accounts  in  the 
sales  ledger.  In  the  same  way,  the  total  of  the  credits  posted 
to  the  individual  creditor  accounts  is  posted  in  total  to  the 
credit  of  the  accounts  payable  controlling  account.  Likewise 
the  total  of  debits  which  are  posted  in  detail  to  the  debit  of  the 
particular  creditor  accounts  is  posted  to  the  debit  of  the  ac- 
counts payable  controlling  account.  It  would  then  be  true  of 
course  that  the  balance  of  the  accounts  payable  controlling  ac- 
count would  be  equal  to  the  sum  of  the  balances  of  the  indi- 

187 


1 88  ACCOUNTING  PRINCIPLES 

vidual  creditor  accounts  which  would  be  found  in  the  purchase 
ledger.  In  taking  the  trial  balance  the  details  in  the  purchase 
ledger  and  in  the  sales  ledger  can  be  omitted,  since  the  accounts 
receivable  controlling  account  represents  a  summary  of  the  in- 
dividual accounts  in  the  sales  ledger  and  the  accounts  payable 
controlling  account  represents  a  summary  of  the  individual  ac- 
counts in  the  purchase  ledger.  If  these  controlling  accounts 
and  all  of  the  other  general  ledger  accounts  make  a  balancing 
trial  balance  when  taken  from  the  general  ledger,  the  general 
ledger  accounts  are  probably  correct.  If  then  the  sum  of  the 
balances  of  the  individual  accounts  in  the  sales  ledger  are  not 
equal  to  the  balance  of  the  accounts  receivable  controlling  ac- 
count, some  of  the  individual  accounts  are  probably  in  error. 
The  clerk  who  keeps  the  customers'  ledger  would  then  be  ad- 
vised to  check  the  entries  in  his  ledger  for  the  purpose  of  dis- 
covering the  error.  It  would  similarly  be  true  that  some  of 
the  accounts  in  the  purchase  ledger  would  likely  be  in  error  if 
the  sum  of  the  balances  of  these  individual  accounts  should 
not  be  equal  to  the  balance  of  the  accounts  payable  controlling 
account.  The  clerk  who  keeps  the  purchase  ledger  would  be 
directed,  in  such  a  case,  to  check  the  entries  in  the  purchase 
ledger  for  the  purpose  of  discovering  the  error.  The  control 
ledgers  would  be  regarded  as  correct  when  the  sum  of  the  bal- 
ances of  the  individual  accounts  in  the  customers'  ledger  were 
equal  to  the  balance  of  the  accounts  receivable  controlling  ac- 
count, and  the  sum  of  the  balances  in  the  purchase  ledger  were 
equal  to  the  balance  of  the  accounts  payable  controlling  ac- 
count in  the  general  ledger. 

2.  Columuar  Journds.  —  In  a  business  of  considerable  size 
it  is  customary  to  provide  the  journals  of  original  entry  with 
colurnns  which  will  serve  to  collect  all  of  the  charges  to  the 
controlling  accounts  receivable  account  and  likewise  the  cred- 
its to  this  account,  and  similarly  it  is  customary  in  such  a  busi- 
ness to  create  columns  in  the  books  of  original  entry  which  will 
provide  for  the  collection  in  columns  of  the  debits  and  credits 
to  accounts  payable.  For  example,  the  total  of  credit  sales  as 
recorded  in  a  sales  journal  or  a  sales  ledger  can  be  collected 


CONTROLLING  ACCOUNTS  AND  COLUMNAR  BOOKS  189 

into  one  column  headed  accounts  receivable.  The  total  of  this 
column  for  a  given  month  would  be  the  total  of  debits  to  the 
controlling  account  of  accounts  receivable  which  arise  from 
credit  sales  to  customers.  Now  the  credits  to  the  controlling 
account  would  arise  in  connection  with  receiving  cash  on  ac- 
count from  individual  customers.  It  would  therefore  be  neces- 
sary to  have  on  the  debit  side  of  the  cash  journal  a  column 
designated  accounts  receivable,  in  order  that  all  of  these  pay- 
ments on  account  might  be  collected  in  a  column  and  added  for 
a  period  such  as  a  month,  so  that  the  total  might  be  carried  to 
the  credit  of  the  accounts  receivable  controlling  account  in  the 
general  ledger.  Likewise  in  the  general  journal  certain  adjust- 
ments in  the  customer  accounts  might  arise  which  would  occa- 
sion debits  to  the  accounts  receivable  controlling  account  and 
also  credits  to  the  same  account.  Consequently,  a  debit  col- 
umn for  accounts  receivable  and  a  credit  column  for  accounts 
receivable  would  be  required  in  the  general  journal.  A  glance 
at  the  columnar  books  of  original  entry  shown  in  Illustration 
No.  22  will  show  how  the  books  of  original  entry  are  designed 
to  provide  columns  for  all  debits  to  accounts  receivable  and  all 
credits  to  that  account  which  might  arise  from  day  to  day  in 
the  entry  of  transactions. 

A  reference  to  Illustration  No.  22  will  further  show  the 
provision  in  the  form  of  columns  which  it  is  necessary  to 
make  in  the  columnar  books  of  original  entry  in  order  to  pro- 
vide for  the  accounts  payable  controlling  account.  Since  these 
accounts  payable  arise  in  connection  with  purchases,  the  large 
volume  of  the  credits  to  accounts  payable  may  be  collected  by 
providing  a  special  column  with  an  accounts  payable  heading 
in  the  purchase  journal  or  purchase  register.  The  most  of  the 
debits  to  accounts  payable  arise  in  connection  with  payments 
on  account  which  would  be  entered  on  the  credit  side  of  the 
cash  journal.  It  is,  consequently,  necessary  to  have  an  ac- 
counts payable  column  on  the  credit  side  of  the  cash  journal  so 
that  all  of  these  debits  may  be  collected  and  carried  as  one  total 
to  the  debit  of  the  accounts  payable  controlling  account.  The 
opening  entry  of  a  credit  to  accounts  payable  would  ordinarily 


IQO  ACCOUNTING    PRINCIPLES 

appear  in  the  general  journal,  and  there  may  be  adjusting  en- 
tries which  would  likewise  appear  in  the  general  journal,  either 
as  debits  to  the  accounts  payable  controlling  account  or  as 
credits  to  it.  It  will  be  desirable,  therefore,  to  have  in  the  gen- 
eral journal  a  debit  column  for  accounts  payable  and  also  a 
credit  colunm  for  accoimts  payable.  If  the  student  will  stop 
at  this  point  and  review  the  illustration  at  the  end  of  the  chapy- 
ter,  it  will  readily  appear  just  what  columns  have  been  pro- 
vided in  order  to  collect  the  information  which  is  required  for 
the  two  controlling  accounts  above  described. 

3.  Discount  Columns.  —  In  the  special  journal  which  had 
only  one  column,  a  cash  discount  was  ordinarily  carried  as  a 
credit  to  cash,  while  the  total  of  the  balance  of  the  customer  ac- 
counts was  represented  as  being  recdved  on  the  debit  side  of 
the  cash  journal.  It  will  readily  appear  that  each  of  such  dis- 
counts on  customers'  accovmts  required  a  posting  to  the  debit 
of  discount  on  sales.  Of  course  the  credit  to  cash  was  automat- 
ically made  by  the  entry  of  the  item  on  the  credit  side  of  the 
cash  journal.  Now  all  of  this  detail  posting  and  also  the  repe- 
tition of  the  description  of  the  original  entry  may  be  saved  by 
the  creation  of  a  column  of  discounts  on  sales  on  the  debit  side 
of  the  cash  journal.  The  total  of  the  amount  of  the  balance  of 
the  customer's  account  may  then  be  entered  in  the  accounts 
receivable  column  on  the  debit  side  of  the  cash  journal  when 
the  customer  pays  his  account,  and  the  amount  of  the  discount 
which  the  customer  receives  may  be  entered  ia  the  parallel  col- 
umn, so  that  the  net  balance  of  cash  received  is  carried  over 
into  the  cash  deposits  column.  It  would  be  clear  that  no  de- 
scription is  necessar\',  except  the  description  at  the  head  of  the 
column.  It  would  further  be  clear  that  no  posting  is  required 
then  except  the  posting  of  the  total  of  the  column  of  the  dis- 
counts on  sales  when  the  books  are  closed.  See  illustration  of 
cash  journal  in  Illustration  Xo.  22,  page  204. 

In  the  same  way,  the  discounts  on  purchases  are  provided  for 
by  a  column  on  the  credit  side  of  the  cash  journal,  so  that  when 
the  total  of  a  bill  is  entered  in  the  accounts  payable  column  on 
the  credit  side  of  the  cash  joiu-nal,  the  discount  appears  in  a 


CONTROLLING  ACCOUNTS  AND   COLUMNAR   BOOKS     IQI 

parallel  column  and  the  cash  withdrawals  in  a  third  column 
shows  the  net  amount  of  cash  paid  in  settlement  of  the  invoice. 
This  column  requires  the  detail  entry  of  the  account  named  at 
the  head  of  the  column  only  and  one  posting  each  time  the 
books  are  closed.  The  use  of  the  column  eliminates  the  account 
entry  for  each  of  the  discount  items  collected  in  the  column. 
See  cash  journal,  credit  page,  Illustration  No.  22,  page  205. 

4.  Classification  Columns.  —  In  the  purchase  and  sales  jour- 
nals heretofore  used,  it  was  impossible  to  classify  purchases  or 
sales  into  groups  of  items.  If  the  separation  were  made,  it  was 
necessary  to  post  each  sales  item  to  a  separate  account  and 
there  was  set  up  the  sales  classification  into  as  many  groups  of 
items  as  might  seem  desirable.  It  is  possible,  however,  by  the 
use  of  columns  to  provide  for  a  classification  of  sales  and  a 
classification  of  purchases  in  the  books  of  original  entry.  It  is 
necessary  to  provide  as  many  colimins  in  the  sales  register,  or 
sales  journal,  as  there  are  classes  of  sales.  It  is  evident  that 
the  same  classes  of  items  would  appear  in  the  purchase  journal 
as  would  appear  in  the  sales  journal,  since  the  chief  reason  for 
classifying  sales  into  groups  is  to  secure  a  figure  for  gross  prof- 
its on  each  class  of  items.  See  purchase  register  and  sales  reg- 
ister in  Illustration  No.  22.  When  sales  and  purchases  are  thus 
classified,  it  is  necessary  to  post  only  the  totals  of  the  several 
columns  to  the  purchase  and  sales  accounts  at  the  time  the 
books  are  closed.  Since  freight-in  is  ordinarily  regarded  as  a 
part  of  the  cost  of  goods  purchased,  it  becomes  necessary  to 
apportion  freight-in  between  the  classes  of  purchases  set  up  in 
the  purchase  register  if  only  one  freight-in  account  is  kept.  It 
is  sometimes  feasible  to  distribute  freight-in  between  the  classes 
of  purchases  on  the  basis  of  the  total  purchases  that  are  shown 
at  the  time  of  closing  the  books  in  the  several  classes  provided 
for.  In  case  this  does  not  prove  to  approximate  fairly  the  ac- 
tual amount  of  freight  incurred  in  connection  with  the  purchases 
in  question,  the  apportionment  must  be  made  on  the  basis  of 
an  estimate  of  the  actual  amount  of  freight  incurred,  and  all  the 
facts  of  the  given  case  must  be  duly  considered  in  making  this 
estimate. 


192  ACCOUNTING  PRINCIPLES 

5.  Columnar  Books.  —  As  we  have  seen,  the  introduction  of 
separate  books  of  original  entry  saves  approximately  fifty  per 
cent  of  the  pKDStings  to  accounts  in  which  the  nimiber  of  entries 
for  any  fiscal  period  is  large.  The  use  of  columnar  books  not 
only  extends  this  saving,  but  provides  the  basis  for  what  are 
known  as  controlling  accounts. 

6.  Coliminar  Cash  Journal.  —  In  the  ordinary  cash  book 
containing  but  a  single  debit  and  a  single  credit  column,  it  is 
necessary  to  write  the  cash  discount  on  the  side  opposite  the 
entry  of  the  purchase  or  sale  and  to  post  each  individual  dis- 
count to  the  ledger.  By  adding,  however,  a  column  for  dis- 
counts on  purchases  next  to  the  credit  column,  it  is  possible 
merely  to  enter  the  amount  of  the  discount  in  the  proper  col- 
unm,  and  to  post  the  total  of  each  as  a  single  item  to  the  ap- 
propriate ledger  accoimt.  Thus,  by  adding  to  the  ordinar\' 
cash  journal  a  number  of  columns  and  by  putting  as  the  head- 
ings of  these  columns  the  names  of  the  accounts  to  which  deb- 
its and  credits  are  most  frequently  made,  we  save  not  only  in 
the  number  of  ledger  postings  but  also  in  the  niunber  of  ac- 
count entries  in  the  cash  book,  the  entry  of  the  amounts  in 
the  proper  colunms  obviating  the  insertion  of  the  account 
names. 

The  ruling  of  the  ordinary  columnar  cash  book  is  shown  in 
Illustration  Xo.  22  below.  When  cash  is  received  on  account, 
the  amount  of  the  invoice  is  entered  in  the  Accounts  Receivable 
colimm,  and,  in  the  absence  of  a  cash  discount,  also  in  the  De- 
posit column.  When  a  cash  discount  is  allowed,  the  amount  of 
the  invoice  is  entered,  as  before,  in  the  Accounts  Receivable  col- 
umn, the  amount  of  the  discount  in  the  Discount  on  Sales  col- 
umn, and  the  net  cash  received,  or  the  amount  of  the  invoice 
less  the  cash  discount,  in  the  Deposit  column.  Similarly,  pay- 
ments on  account,  when  no  cash  discount  is  taken,  are  entered 
in  the  Accounts  Payable  and  Withdrawal  columns.  The  De- 
posit and  Witfidrcnval  columns  thus  represent  the  debits  and 
credits  to  cash. 

7.  Columnar  Purchase  Journal.  —  In  the  ordinary  purchase 
book  or  register,  there  is  frequently  only  one  money  column 


CONTROLLING  ACCOUNTS  AND  COLUMNAR  BOOKS     193 

showing  the  amount  of  merchandise  purchases.  When  such  is 
the  case,  the  total  of  this  column  is  debited  to  the  merchandise 
purchases  account,  the  offsetting  credits  being  posted  in  detail 
to  the  accounts  of  the  concerns  from  which  the  purchases  are 
made.  Quite  often  it  is  desirable  to  classify  the  various  pur- 
chases, in  order  to  determine  the  profits  arising  from  each  sep- 
arate class.  To  do  this  with  the  ordinary  purchase  book,  it  is 
necessary  to  have  as  many  purchase  registers  as  there  are  items 
in  the  classification,  with  the  result  that  a  single  invoice  may 
involve  a  number  of  separate  entries.  Obviously,  the  same  in- 
formation is  more  readily  supplied  by  means  of  additional  col- 
umns in  the  purchase  journal,  whereby  the  total  of  the  invoice 
may  be  entered  in  one  column,  and  the  amounts  chargeable  to 
the  various  classes  in  parallel  columns  to  the  right.  The  classi- 
fication adopted  will,  of  course,  determine  the  number  of  col- 
umns to  be  used  and  the  character  of  the  purchase  accounts  to 
be  kept  on  the  ledger. 

A  form  of  columnar  purchase  journal,  ruled  to  fit  the  trans- 
actions of  the  particular  example,  is  shown  in  Illustration  No. 
22,  below.  The  total  of  the  Accounts  Payable  column  repre- 
sents the  aggregate  of  the  detailed  ppstings  to  the  credit  of  the 
individual  accounts  payable,  while  the  totals  of  the  Furniture 
column  and  the  Mattresses  column  show  the  amounts  to  be  deb- 
ited to  the  corresponding  ledger  accounts,  these  two  accounts 
replacing  the  single  account  of  merchandise  purchases. 

8.  Columnar  Sales  Journal.  —  A  columnar  sales  journal  ordi- 
narily follows  the  classification  of  the  columnar  purchase  regis- 
ter, or  vice  versa.  Thus,  in  the  form  of  the  sales  journal  illus- 
trated below,  the  sales  are  divided  into  furniture  sales  and 
mattress  sales  to  correspond  with  the  purchase  classification  es- 
tablished in  the  purchase  journal.  The  total  of  the  Accounts  Re- 
ceivable column  represents  the  aggregate  of  the  detailed  post- 
ings to  the  debit  of  the  various  individual  accounts  receivable, 
while  the  totals  of  the  columns  representing  furniture  and  mat- 
tress sales  denote  the  amount  to  be  credited  to  the  correspond- 
ing ledger  accounts,  which  together  replace  the  merchandise 
sales  account. 


194  ACCOUNTING  PRINCIPLES 

9.  Columnar  General  Journal.  — •  With  the  use  of  the  various 
columnar  books,  the  number  of  entries  in  the  general  journal 
becomes  comparatively  small.  It  contains,  as  explained  before, 
merely  the  opening,  closing,  adjustment  entries,  purchases  in- 
volving expense,  and  such  other  entries  as  are  not  provided  for 
in  the  separate  columnar  journals.  A  form  of  general  jour- 
nal meeting  the  requirements  of  the  transactions  involved  is 
shown  in  Illustration  No.  22,  page  200. 

It  will  be  noticed  that  the  columnar  headings  for  the  journal 
are  similar  to  the  headings  found  in  the  columnar  cash  book, 
the  columnar  purchase  register,  and  the  columnar  sales  register. 
The  Accounts  Payable  column  provides  for  transactions  affect- 
ing creditors  other  than  merchandise  creditors  and  for  entries 
afifecting  the  accounts  of  the  latter  arising  out  of  adjustments 
rather  than  from  purchases  or  payments  on  account.  Thus, 
purchases  of  machinery  and  equipment  and  of  other  fixed  as- 
sets are  entered  in  the  general  journal.  The  Accounts  Re- 
ceivable column,  on  the  other  hand,  provides  for  credit  sales  of 
fixed  assets  and  for  adjustment  in  accounts  receivable. 

10.  Return  Purchases  and  Sales.  —  Where  the  volume  of 
return  purchases  and  sales  is  large,  it  is  of  advantage  to  the 
manager  to  have  the  data  entered  in  separate  accounts  under 
the  headings  Returns  and  Allowances  on  Purchases  and  Returns 
and  Allowances  on  Sales.  For  convenience,  these  accounts  may 
be  kept,  respectively,  in  the  back  of  the  regular  purchase  and 
sales  journals,  the  rulings  of  which  are  adapted  to  the  purpose. 

11.  Controlling  Account  Entries.  —  A  controlling  account  is 
a  summary  of  a  group  of  accounts  of  the  same  kind.  Take,  for 
example,  the  customer  accounts,  of  which  there  may  be  a  large 
number.  If,  along  with  these  accounts,  there  is  kept  a  separate 
account  containing  on  the  debit  side  the  sum  of  all  the  debits 
to  the  customer  accounts,  and  on  the  credit  side  the  total  of  all 
the  credits  to  the  latter  accounts,  there  results  a  controlling  ac- 
count or  summary  for  accounts  receivable.  Obviously,  the  bal- 
ance of  the  summary  or  controlling  account  is  equal  to  the  sum 
of  the  balances  of  the  individual  customer  accounts  of  which 
the  former  is  composed. 


CONTROLLING  ACCOUNTS  AND  COLUMNAR   BOOKS     1 95 

The  creditor  accounts  may,  of  course,  be  summarized  in  pre- 
cisely the  same  way.  On  the  credit  side  of  the  controlhng  ac- 
count in  this  case  are  entered  in  total  the  various  credits  to  the 
individual  creditor  accounts,  while  on  the  debit  side  are  entered 
in  a  lump  the  different  debits  to  the  latter  accounts.  The  bal- 
ance of  the  controlling  account,  therefore,  is  equal  to  the  sum 
of  the  balances  of  the  several  individual  accounts  payable. 

A  special  word  of  explanation  is  necessary  in  connection 
with  the  postings  from  the  pages  of  the  purchase  and  sales  reg- 
isters devoted  to  returns  and  allowances  on  purchases  and  sales. 
Manifestly,  the  commodity  classifications  and  controlling  ac- 
count columns  are  identical  in  these  special  sections  with  those 
of  the  purchase  and  sales  journals  proper.  The  posting  to  the 
ledger  of  the  totals  of  the  controlling  account  columns  is,  how- 
ever, radically  different.  In  the  purchase  register,  all  accounts 
payable  items  are  credits  to  the  individual  creditor  accounts, 
and  the  total  of  these  items  a  credit  to  the  controlling  creditor 
account.  Goods  purchased  but  returned,  on  the  other  hand, 
become  a  debit  to  accounts  payable;  and  hence  the  accounts 
payable  column  of  the  purchase  returns  and  allowances  journal 
is  posted  as  a  debit  to  the  account  controlling  accounts  pay- 
able. Similarly,  the  accounts  receivable  column  of  the  sales 
returns  and  allowances  journal  represents  a  credit  to  the  con- 
trolling customer  account,  and  not  a  debit,  as  does  the  ac- 
counts receivable  column  of  the  sales  register. 

12.  Purchase  Ledger.  —  To  derive  the  full  advantage  of  a 
controlling  account,  all  accounts  covered  by  it  should  be 
grouped  in  a  separate  ledger.  If  all  the  purchase  accounts  are 
thus  segregated,  this  subsidiary  ledger  becomes  known  as  the 
purchase  ledger,  and  the  book  heretofore  called  the  ledger  de- 
velops into  what  is  termed  the  general  ledger.  In  order  that 
the  general  ledger  may  contain  all  the  data  needed  for  a  trial 
balance,  there  is  inserted  in  it,  in  place  of  the  individual  ac- 
counts which  have  been  transferred  to  the  purchase  ledger,  a 
summary  or  controlling  account  covering  the  various  accounts 
payable.  Consequently,  the  individual  accounts  payable  no 
longer  appear  in  the  trial  balance  or  in  the  balance  sheet,  but 


196  ACCOUNTING  PRINCIPLES 

are  submitted  as  a  separate  schedule  to  show  that  the  subsidi- 
ary ledger  is  in  accord  with  the  controlling  account  of  the  gen- 
eral ledger. 

As  the  sum  of  the  balances  of  the  individual  accoimts  must 
equal  the  balance  of  the  controlling  account,  it  is  clear  that  a 
difference  in  these  amounts  indicates  that  an  error  has  been 
made  either  in  the  controlling  account  or  in  the  purchase  ledger. 
In  case  the  trial  balance  proves  correct,  it  is  equally  clear 
that  the  error  must  be  sought  in  the  individual  accounts 
payable. 

13.  Sales  Ledger.  —  The  sales  ledger  is  created  as  another 
subsidiary  ledger  to  be  governed  by  the  accounts  receivable 
controlling  account  in  the  general  ledger.  If  a  trial  balance 
taken  from  the  general  ledger  shows  an  equality  of  assets  and 
liabilities,  any  discrepancy  between  the  sum  of  the  balances  of 
the  sales  ledger  and  the  balance  of  the  controlling  account  clearly 
indicates  an  error  in  the  individual  accounts  receivable. 

14.  Value  of  Controlling  Accounts.  —  Because  postings  could 
be  made  in  totals,  much  saving  of  time  and  effort  was  effected 
through  the  introduction  of  the  merchandise  purchases  and 
merchandise  sales  accounts.  They  are  in  no  sense,  however, 
controlling  accounts,  there  being  no  group  of  subsidiary  ac- 
counts fully  represented  in  total  by  either  of  them. 

Controlling  accounts  present  a  means  of  condensing  into 
summary  form  in  the  general  ledger  a  large  number  of  accounts 
which  are  kept  in  detail  in  one  or  more  subsidiary  ledgers.  Thus 
the  general  ledger  remains  a  small  book  that  can  be  easily  used 
at  any  time  for  the  purpose  of  taking  a  trial  balance  and  cal- 
culating profits,  without  even  attempting  a  balance  of  the  vari- 
ous subsidiary  ledger  accounts.  Should  an  error  develop,  it 
can  be  easily  limited  either  to  the  general  ledger  or  to  one  of 
the  subsidiary  ledgers.  Without  a  controlling  account,  it  would 
be  necessary  to  check  all  of  the  accounts  in  order  to  locate  the 
discrepancy.  Moreover,  as  the  subsidiary  ledgers  are  usually 
placed  in  the  hands  of  special  clerks,  only  the  general  ledger 
clerk  need  know  the  general  condition  of  the  business,  or 
whether  it  is  succeeding  or  failing.     The  larger  the  business, 


CONTROLLING  ACCOUNTS  AND   COLUMNAR  BOOKS     197 

therefore,  the  more  important  becomes  the  use  of  controlling 
accounts. 

15.  Interest  in  the  Columnar  Cash  Journal.  —  In  the  ordi- 
nary cash  journal  with  only  one  column  for  debits  and  another 
for  credits,  the  most  feasible  plan  is  to  enter  the  discount  of  a 
note  payable  on  the  credit  side  and  the  face  of  the  note  on  the 
debit  side.  There  are  objections,  however,  to  this  procedure, 
as  it  increases  the  total  of  deposits  as  indicated  by  the  cash 
journal  to  an  amount  larger  than  the  total  as  shown  by  the  bank 
pass  book,  although  the  balances  of  these  two  books  should  be 
the  same  when  all  checks  issued  have  been  cashed  by  the 
bank.  Usually,  however,  a  number  of  checks  issued  toward 
the  end  of  the  month  remain  outstanding  when  the  bank  book 
is  balanced  and  returned,  making  a  reconciliation  between  the 
pass  book  and  the  cash  book  necessary.  This  reconciliation  is 
obviously  greatly  facilitated  when  the  total  deposits  and  the 
total  withdrawals  are  the  same  in  both  the  cash  and  the  bank 
account. 

The  desired  result  is  easily  accomplished  in  the  columnar 
cash  journal  by  entering  the  face  of  the  note  in  the  general  col- 
umn opposite  the  entry  of  notes  payable  as  the  account  to  be 
credited.  The  bank  discount  is  then  entered  in  red  directly 
under  the  entry  of  the  face  of  the  note  in  the  general  column 
opposite  the  entry  of  interest  as  the  account  to  be  credited,  the 
net  amount  of  the  note  being  entered  in  the  deposit  column.  As 
the  interest  account  is  debited  with  the  amount  of  the  discount, 
this  particular  entry  must  be  differentiated  from  the  prevailing 
credits  on  the  debit  side  of  the  journal  by  being  written  in  red 
ink.  Entries  involving  notes  receivable  discounted  are,  of 
course,  made  in  the  same  way.  An  example  will  be  foimd  in 
Dlustration  No.  22,  page  204. 

16.  Illustration.  —  The  illustration  given  below  is  intended 
to  show  how  items  are  entered  in  the  different  columnar  books, 
how  the  books  are  used,  how  the  postings  to  the  controlling  ac- 
counts are  made,  and  how  the  books  are  closed  at  the  time  of 
taking  a  trial  balance.  Although  the  purchase  and  sales  ledg- 
ers, showing  the  individual  accounts  of  creditors  and  custom- 


igS  ACCOUNTING  PRINCIPLES 

ers,  are  omitted  to  economize  space,  there  is  inserted  below 
the  balance  sheet  a  list  of  the  balances  from  these  ledgers  as 
supporting  schedules  for  the  balances  of  the  controlling  ac- 
counts. 

Transactions  for  Illustration  No.  22 

John  Smith  and  John  Doe  on  January  i,  191 9,  begin  conducting  a 
general  partnership  under  the  firm  name  of  the  Central  Furniture 
Store.  John  Smith  invests  $10,000.00  and  John  Doe  $30,000.00,  but 
they  agree  that  three  fourths  of  the  profits  and  losses  shall  go  to  Doe 
and  one  fourth  to  Smith,  and  aUow  themselves  salaries  of  $40.00  per 
week  each.  They  deal  in  furniture  and  mattresses,  and  keep  their 
purchases  and  sales  accounts  with  these  two  classes  of  goods.  Their 
transactions  are  as  follows: 

Jan.  I  Purchases  on  credit:  Sample  Furniture  Co.,  2/10,  n/30, 
furniture,  $5,000.00;  mattresses,  $2,000.00  —  Haywood 
Furniture  Co.,  2/10,  n/30,  furniture,  $500.00;  mat- 
tresses. $250.00. 

Purchased  ofiice  equipment  for  $350.00  cash.  Took  out  of 
stock  additional  office  furnishings  costing  $150.00. 
Purchased  stationery  for  $25.00  cash. 

Credit  sales:  Valley  Hospital,  2,'io,  n  '30,  furniture,  $750.00; 
mattresses,  $200.00  —  W.  H.  Meyer,  furniture,  $28.50; 
mattresses,  $7.50  —  J.  J.  Hewitt,  2/10,  n/30,  furniture, 
$400.00;  mattresses,  $150.00. 
2     Cash  sales,  furniture,  $800.00. 
2    Purchased  deUvery  truck  for  $1,500.00  cash. 
6    Transactions  for  remainder  of  week  entered  under  this  date. 

Paid  on  account:  Sample  Furniture  Co.,  invoice  of  Jan.  i, 
less  discount;  Ha>'wood  Furniture  Co.,  invoice  of  Jan. 
'  I,  less  discount. 

Credit  purchases:  T.  &  G.  Morgan,  furniture,  $6,000.00; 
mattresses,  $2,560.00  —  H.  E.  Duncan,  fumitiu-e, 
$5,860.00;  mattresses,  $1,850.00  —  W.  T.  Hamer,  fiu"- 
nitixre,  $7,280.00;  mattresses,  $3,260.00. 

Received  on  account:  Valley  Hospital,  invoice  of  Jan.  i,  less 
discount  —  J.  J.  Hewitt,  invoice  of  Jan.  i,  less  discovmt. 

Purchased  lot  and  building  for  $10,000.00  from  K.  C.  Jones 
Realty  Co.,  of  which  $3,500.00  was  for  the  lot  and 
$6,500.00  for  the  building.  The  firm  paid  $7,500.00 
in  cash  and  gave  a  five-year  8%  mortgage  for  the 
balance. 


CONTROLLING  ACCOUNTS  AND  COLUMNAR  BOOKS  1 99 

Purchased  three  tons  of  coal  from  the  City  Coal  Co.  for 
office  use,  paying  $18.00  cash. 

Paid  for  salaries:  Managers,  $80.00;  R.  L.  Kaid,  $30.00; 
J.  P.  Johns,  $35.00;  H.  R.  Salder,  $35.00. 

Sales  on  credit,  2/10,  n/30':  J.  Collins,  furniture,  $250.00 — 
H.  P.  Henderson,  furniture,  $160.00;  mattresses, 
$80.00 — ^J.  H.  Brigham,  furniture,  $250.00;  mat- 
tresses, $90.00 — St.  Luke  Hospital,  furniture,  $2,- 
750.00;  mattresses,  $750.00.  National  University,  fur- 
niture, $5,600.00;  mattresses,  $1,750.00. 

Cash  sales:  Furniture,  $8,500.00;  mattresses,  $3,260.00. 
13     Transactions  for  the  week  ending  on  this  date. 

Paid  on  account:  T.  &  G.  Morgan,  $6,000.00;  H.  E.  Duncan, 
invoice  less  discount;  W.  T.  Hamer,  invoice  less  dis- 
count. 

By  agreement,  the  firm  drew  a  30-day  draft  on  the  St.  Luke 
Hospital  for  $3,430.00,  to  cover  account  less  discount, 
the  hospital  accepting  the  draft. 

Discounted  at  5.808%  at  the  Central  Trust  Co.  the  30-day 
draft  of  the  St.  Luke  Hospital, 


200 


ACCOUNTING  PRINCIPLES 


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CONTROLLING  ACCOUNTS  AND   COLUMNAR  BOOKS     207 

GENERAL  LEDGER 

„    Notes  Receivable 


1919 
Jan. 


13 


J200 

3430 

00 

I9I9 

Notes  Receivable  Discounted 


I9I9 

Jan. 

13 

C204 


3430 


Accounts  Receivable 


I9I9 

1919 

Jan. 

13 

8216 

S206 

13216 

00 

Jan. 

13 
13 

C204 
J201 

1500 
3500 
5000 

00 
00 
00 

Mdse.  Inventory 


1919 
Jan. 


13 


IJ201 


155801 


Land 


1919 
Jan. 


J  200 


3500 ' 


Buildings 


1919 
Jan. 


J200 


6500  ( 


2o8 


ACCOUNTING  PRINCIPLES 
Furniture  and  Fixtures 


I9I9 

I9I9 

Jan. 

13 

J200 

15c 

DO 

I 

500 

C20S 

350 

00 

Deuvery  Equipment 


I9I9 

Jan. 

2 

C20S 

1500 

00 

Accounts  Payable 


I9I9 

1919 

Jan. 

13 

C20S 

26000 

00 

Jan. 

13 

13 

C20S 

6000 

00 

2560 


P203!  34560 


Mortgage  (Notes)  Payable 


I9I9 

Jan. 

6 

J200      2500 


John  Smith,  Capital 


I9I9 
Jan. 

13 

Balance 

1 183 1 

60 

1919 
Jan. 

Jan. 

I 
13 

14 

1 183 1 

60 

NetProfit(i) 
Bal.  Cap. 


J202 


lOOOO 

I83I 


11831 


II83I 


60 


John  Doe,  Capital 


1919 
Jan. 


13 

Balance 

35494 

80 

1919 
Jan. 

I 
13 

14 

35404 

80 

Jan. 

XetProfit(}) 
Balance 


30000 
J202I     5494 


35494 


35494 


CONTROLLING  ACCOUNTS  AND  COLUMNAR  BOOKS     209 
Furniture  Purchases 


1919 
Jan. 


13 


Trading 


J200 
J201 


ISO 
24490 


2^640 


Mattress  Purchases 


1919 
Jan. 


13 


P203 

9920 

00 

I9I9 

Jan. 

13 

Trading 


J201 


9920 


Furniture  Sales 


T919 
Jan. 


13 


Trading 


J20I 

19488 

50 

I9I9 

Jan. 

13 

S206 


50 


Mattress  Sales 


1919 
Jan. 


13 


Trading 


J  201 

6487 

50 

191c; 

Jan. 

13 

S206 


6487 


50 


Discount  on  Sales 


I9I9 

Jan. 

13 
13 

J200 
C20S 

70 
30 

00 
00 

1919 
Jan. 

.13 

Profit  &L. 

J201 

100 

00 

100 

00 

100 

00 

Interest 


1919 
Jan. 


C20S 

16 

60 

I9I9 

Jan. 

JA 

Profit  &  L. 


J201 


16 


60 


2IO 


ACCOUNTING  PRINCIPLES 


Discount  on  Purchases 
F 


1919 

Jan. 


13 


Profit  &  L. 


J2C 


!i20 


I9I9 

Jan. 


13 


C206 


520 


General  Expense 


1919 
Jan. 


C206 

2<i 

00 

I9I9 

Jan. 

13 

Profit  &  L. 


Office  Expense 


J201 


2."; 


1919 

Jan. 


Profit  &  L. 


J201 


1919 
Jan. 


C20S 

180 

00 

I9I9 

Jan. 

U 

Profit  &  L. 


J201 


Trading 


I9I9 

I9I9 

Jan. 

13 

Fur.  Purch. 

J201 

24490 

00 

Jan. 

13 

Mdse.  Inv.  end 

MattressPur. 

J201 

9920 

00 

of  period 

J201 

15580 

00 

Gross  Profit 

J201 

7146 

oc 

Fur.  Sales 
Mattress 

J201 

19488 

SO 

"" 

00 

Sales 

J201 

6487 

50 

41556 

41556 

00 

Profit 

AND 

Loss, 

Jan.  I 

TO  Jan.  13,  19] 

9 

1919 

1915 

Dis.  on  Sales 

J201 

100 

00 

Gross  Profit 

J3    7146 

oc 

Interest 

J201 

le 

6c 

Disc,  on  Pur. 

J200      520 

00 

Gen.  Exp. 

J201 

25 

X. 

Office  Exp. 

J201 

li 

oc 

Off  Salaries 

J201 

i8c 

00 

Net  Profit 

J202 

7326 

4C 

7666 

00 

7666 

CO 

CONTROLLING   ACCOUNTS  AND   COLUMNAR   BOOKS     21 1 

Balance  Sheet,  Central  Furniture  Store,  January  13,   1919 

Assets  Liabilities 

Cash  16,590.40       Accounts  Payable        2,560.00 

Accounts  Receivable  (See  A)  8,216.00       Mortgage  Payable       2,500.00 

Notes  Receivable       3,430.00  John  Smith, Capital    11,831.60 

Less  Notes  Rec.  Dis.  3,430.00       John  Doe,  Capital     35,494.80 

Mdse.  Inventory  15,580.00 

Delivery  Equipment  1,500.00 

Furniture  and  Fixtures  500 .  00 

Land  3,500.00 

Buildings  6,500.00 


$52,386.40  $52,386.40 


Schedule  A 

Accounts  Receivable 

W.  H.  Meyer 

$36.00 

J.  Collins 

250.00 

H.  P.  Henderson 

240.00 

J.  H.  Brigham 

340.00 

National  University 

7-3SO.OO 

$8,216.00 

Schedule  B 

Accounts  Payable 

T.  and.  G  Morgan  $2,560.00 


QUESTIONS   AND   PROBLEMS 

1.  Describe  the  accounts  receivable  controlling  account,  showing  what 
debits  and  credits  are  made  to  the  account. 

2.  Give  the  same  treatment  to  the  accounts  payable  controlling  account. 

3.  Show  what  advantages  accrue  from  these  controlling  accounts. 

4.  Show  the  amount  of  economy  arising  from  the  introduction  of  the 
column  for  discounts  on  sales  and  the  column  for  discounts  on  purchases. 

5.  The  firm  of  Pelton  and  Winslow  keeps  the  following  books:  Journal, 
with  these  columns:  Accounts  Payable,  Dr.,  Accounts  Receivable,  Dr., 
General,  Dr.,  General,  Cr.,  .\ccounts  Receivable  Cr.,  .\ccounts  Payable,  Cr. 

Cash  Book,  with  columns  as  follows:  Debit  side:  General,  Accounts  Re- 
ceivable, Discount  on  Sales,  Bank  Deposits;  credit  side:  General,  Accounts 
Payable,  Discount  on  Purchases,  Bank  Withdrawals. 

Sales  Register,  Purchase  Register,  Returned  Sales  Register,  all  with  these 
columns:  Amount,  Farm  Implements,  Hardware. 

The  bookkeeper  starts  to  post  the  books  and  takes  a  trial  balance.  After 
he  posts  all  the  details  in  the  general  columns  of  the  cash  book,  the  journal 
and  the  individual  items  in  the  Sales,  Purchase,  and  Returned  Sales  Registers 


212  ACCOUNTING  PRINCIPLES 

and  before  he  posts  any  of  the  footings  in  the  books  of  original  entry,  the 
balances  in  the  various  accounts  in  the  general  ledger  stand  as  follows: 


Henry  Pelton,  Capital 

25,500.00 

Charles  Winslow,  Capital 

20,400.00 

Furniture  and  Fixtures 

493.00 

Horses  and  Wagons 

475-00 

Henry  Pelton,  Drawing 

184.12 

Charles  Winslow,  Drawing 

234 -35 

Notes  Receivable 

2,807.10 

Notes  Payable 

10,500.00 

Farm  Implements — Purchases 

27,447.85 

Hardware  Purchases 

3.731-77 

Hardware  Sales 

2,417.80 

Farm  Implement  Sales 

1,619.10 

Salaries 

284.00 

General  Expense 

172.60 

Freight  and  Cartage  In 

517-32 

Freight  and  Cartage  Out 

58-75 

Advertising 

325.00 

Interest 

18.43 

Stationery  and  Printing 

132 -IS 

Insurance 

252.04 

Rent 

100.00 

Stable  Expense 

34-30 

Notes  Receivable  Discounted 

2,000.00 

Wm.  Draper,  Loan  Account 

6,000.00 

Petty  Cash 

200.00 

37,467.78       68,436.90 

At  the  same  time  the  footings  in  the  books  of  original  entry  are  as  follows: 

Cash  Book,  Debits:  General  61,998.70;  Accounts  Receivable,  7,691.14; 
Discount  on  Sales,  128.84;  Bank  Deposits,  69,561.00. 

Cash  Book,  Credits:  General,  29,669.90;  Accounts  Payable,  37,774.35; 
Discount  on  Purchases,  899.17;  Bank  Withdrawals,  66,545.08. 

Journal:  Accounts  Receivable,  Debit,  1,899.02;  General,  Debit,  21,943.34; 
General,  Credit,  20,583.66;  Accounts  Payable,  Credit,  758.70;  Accounts 
Receivable,  Credit,  2,500.00. 

Sales  Register:  Amount,  13,540.45;  Farm  Implements,  10,444.35; 
Hardware,  3,096.10. 

Purchase  Register;  Amount,  40,755.50;  Farm  Implements,  36,467.15; 
Hardware,  4,288.35. 

Returned  Sales  Raster:   Amount,  125.06;  Farm  Implements,  90.00; 
Hardware,  35.00. 
Complete  the  postings  and  show  the  trial  balance  as  it  finally  appeared. 

Suggestions: 

Remember  that  the  details  in  the  general  column  of  each  book  have  been  posted,  and 
that  the  totals  of  the  general  columns  are  not  to  be  posted.  A  cash  account  is  kept  in 
the  ledger  under  the  name  of  the  Bank  at  which  deposits  are  made.  Accounts  receivable 
and  accounts  payable  have  not  yet  been  opened  in  the  ledger.  Think  carefully  before  mak- 
ing any  postings,  and  be  sure  that  the  postings  are  made  to  the  proper  side  of  each  account. 


CONTROLLING  ACCOUNTS  AND   COLUMNAR  BOOKS     213 

6.  (a)  Sales  Register. — Design  a  sales  register  to  care  for  the  sales  of 
the  Whitman  Wholesale  Company.  All  sales  are  made  on  the  same  terms 
2/10,  n/30.  Sales  are  to  be  listed  under  the  following  heads:  Men's  Fur- 
nishings, Shoes,  Clothing,  Hats.  Indicate  the  postings  to  be  made  at  the 
end  of  the  month. 

(b)  Sales  Register. — Design  a  sales  register  for  the  Hawthorne 
Stationery  Company.  This  company  does  not  care  to  departmentalize  its 
sales,  but  wishes  to  keep  trace  of  its  sales  according  to  terms.  Its  sales  are 
made  either  to  regular  customers  on  account  (there  are  two  customers' 
ledgers,  one  for  city  accounts  and  one  for  country  accounts),  C.  O.  D.,  for 
cash,  or  on  notes  receivable.  Indicate  the  postings  to  be  made  at  the  end 
of  the  month. 


CHAPTER  XVI 
THE  BILL  BOOK 

I.  The  Bill  Book  as  a  Memorandtun  Book  or  as  a  Journal. 

—  Because  of  the  large  amount  of  information  to  be  entered  in 
connection  with  notes  receivable  and  notes  payable,  a  specially 
prepared  book  is  used  to  make  a  proper  record  of  them.  This 
book,  known  as  a  bill  book,  may  serve  merely  as  a  memoran- 
dum record  to  which  the  journals  refer,  or  be  used  as  one  of 
the  auxiliary  journals  of  the  business.  The  column  headings 
for  a  notes  receivable  journal  might  be  arranged  as  indicated 
below,  thus  providing  for  acceptances  as  well  as  promissory 
notes.  The  notes  payable  record  would  occupy  a  separate  sec- 
tion of  the  same  book,  and  require  substantially  the  same  rul- 
ing, the  column  Accounts  Credited  in  the  notes  receivable  rec- 
ord becoming  Accounts  Debited  in  the  record  of  notes  payable. 
(See  Illustration  23  and  23A  below.) 

The  figures  in  the  money  columns  with  the  ledger  folio 
spaces  to  the  left  are  the  only  amounts  to  be  posted  from  the 
bill  book  in  case  it  is  used  as  a  note  journal.  When  a  note  is 
received,  one  or  more  accounts  must  be  credited,  and  notes  re- 
ceivable debited  for  the  face  of  the  note.  If  partial  payments 
are  received  on  a  note,  these  must  be  entered  through  the  cash 
journal,  though  these  payments  should  be  noted  in  the  bill 
book  so  that  the  balance  unpaid  may  be  readily  calculated.  It 
is  of  value  also  to  have  in  the  note  journal  a  memorandum  of 
the  rate  paid  in  connection  with  the  discount  of  a  note  and  of 
the  name  of  the  discounter,  even  if  the  transaction  itself  must 
be  journalized  in  the  cash  book.  The  rate  is  entered  in  a  special 
column,  and  the  name  of  the  discounter  ordinarily  in  the  Re- 
marks column  to  the  extreme  right.  If  cash  is  received  in  con- 
nection with  a  note  payable,  the  proper  entry  should  be  made 
at  once  in  the  cash  journal  and  in  the  notes  payable  record, 

214 


THE   BILL   BOOK  215 

and  checked  in  both  journals  to  indicate  that  no  ledger  posting 
is  required. 

Transactions  for  Illustration  No.  23 

1919 

Jan.  I  Received  from  G.  B.  Sanders  in  full  settlement  of  his  account 
note  (No.  i)  for  $200.00,  dated  Jan.  i,  1919,  and  payable 
at  the  Valley  National  Bank  three  months  after  date, 
with  interest  at  8%. 

2  Received  from  John  Doe  in  full  settlement  of  his  past-due 

account  of  $145.00  and  interest  thereon  of  $5.00  note 
(#2)  for  $150.00,  dated  Dec.  i,  1918,  endorsed  by  Richard 
Roe,  and  payable  at  the  Valley  National  Bank  three 
months  after  date,  with  interest  at  8%. 

3  Received  from  John  Smith  in  full  settlement  of  his  account 

his  30-day  draft  (#3)  for  $300.00,  dated  Jan.  3,  1919, 
accepted  by  Wm.  Jones,  and  discounted  it  at  8%  at  the 
Valley  National  Bank. 

4  Received  from  John  King  in  settlement  of  his  $500.00  ac- 

count $250.00  cash  and  note  (#4)  for  the  balance,  dated 
Jan.  4,  1919,  and  payable  at  the  Valley  National  Bank  30 
days  after  date,  with  interest  from  maturity  at  8%. 
Made  a  note  to  the  Valley  National  Bank  for  $500.00,  90 
days,  at  8%  discount. 

8  Made  a  note  of  $500.00  for  60  days  at  7%  in  settlement  of 

an  account  with  the  Sample  Furniture  Co. 

9  Accepted  a  30-days'  time  draft  for  $350.00  in  settlement  of 

an  account  with  the  Haywood  Furniture  Co.,  interest 
6%,  payable  at  First  National  Bank,  Chicago. 


2l6 


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THE  BILL  BOOK 


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THE  BILL  BOOK 


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220  ACCOUNTING  PRINCIPLES 

The  foregoing  transactions  having  been  entered  in  the  note 
journal,  accounts  receivable  should  be  credited  for  $895.00,  in- 
terest with  $5.00,  and  the  individual  accounts  listed  under  Ac- 
counts Credited,  credited  with  the  amount  set  opposite  each,  the 
ledger  reference  being  entered  in  the  folio  column  as  the  vari- 
ous postings  are  made.  The  notes  should  be  numbered  consecu- 
tively as  entered  on  the  record,  and  designated  by  number  on 
the  cash  book  entries  when  paid,  so  that  reference  to  the  record 
in  the  bill  book  may  be  quickly  and  easily  made. 

If  used  merely  as  a  memorandum  record,  the  bill  book  need 
have  no  folio  column  for  the  ledger  posting.  The  notes  in  this 
case  are  entered  in  detail  in  the  general  journal,  and  are  iden- 
tified by  their  bill  book  number,  so  that  the  complete  data  con- 
cerning them  may,  if  necessary,  be  obtained.  In  that  case  the 
money  column  would  be  Notes  Receivable  or  Notes  Payable,  as 
the  case  might  be,  instead  of  the  three  money  columns  found 
above.  Obviously,  if  a  large  number  of  notes  is  received,  the 
bill  book  should  be  made  an  auxiliary  journal  rather  than  a 
memorandum  record  of  notes  given  and  received. 

2.  The  Note  Payable  Journal  and  Cash.  —  If  a  note  payable 
is  made  for  cash,  no  account  need  be  entered  on  the  debit  side 
of  the  cash  journal  opposite  the  entry  of  the  amount  of  cash 
received.  The  memorandum  and  folio  space  should,  however, 
refer  to  the  original  entry  in  the  Note  Payable  Journal.  The 
folio  of  the  Note  Payable  Journal  should  refer  to  the  cash  jour- 
nal page  where  the  amount  of  cash  is  entered. 

3.  Note  Accounts  as  Controlling  Accounts.  —  If  a  business 
used  notes  and  expected  that  many  installments  should  be  paid 
on  a  note  without  renewing  it,  a  notes  receivable  or  payable  ac- 
count would  not  be  sufficient.  It  would  be  desirable  to  carry 
a  subsidiary  account  with  each  of  such  notes  just  as  the  debt 
would  be  treated  in  an  open  account. 

QUESTIONS  AND  PROBLEMS 

I.  Make  the  following  entries  in  the  bill  book,  which  is  to  be  used  as  a 
journal  both  for  notes  receivable  and  for  notes  payable.  Accounts  payable 
and  accounts  receivable  are  to  be  provided  for  as  controlling  accounts. 


THE  BILL  BOOK  221 

1919 

July  I  The  Valley  Furniture  Store  draws  a  30-day  draft  on  John  Smith 
for  $250.00  covering  a  shipment  of  goods.  Smith  accepts 
the  draft  as  payable  at  the  Valley  National  Bank.  The  draft 
draws  interest  from  maturity  at  8%.  The  note  is  discovmted 
at  once  at  the  bank  at  6%. 

2  The  firm  gives  to  Fielding  Co.  for  merchandise  purchases  on  ac- 

count a  note  of  $500.00  payable  60  days  after  date  at  the 
Valley  National  Bank,  with  interest  at  8%. 

3  John  Smith  pays  his  account  of  $300.00  with  a  90-day  note  en- 

dorsed by  John  Doe,  and  payable  at  the  Central  National 
Bank,  Centre,  111.,  with  interest  at  8%. 

4  The  firm  accepts  in  settlement  of  its  accoimt  a  60-day  draft  of 

the  Sample  Furniture  Co.,  dated  July  i,  making  it  payable  at 
the  Valley  National  Bank. 

5  The  firm  discounts  at  6%  at  the  Valley  National  Bank  its  90-day 

note  for  $400.00,  endorsed  by  John  Smith. 

6  The  firm  settles  with  the  Grand  Rapids  Furniture  Co.  for  its 

overdue  account  by  giving  its  note  for  $300.00,  due  in  60  days 
at  the  Valley  National  Bank,  with  interest  at  6%. 

7  The  firm  receives  from  John  Ray  in  settlement  of  his  accoimt  a 

note  for  $125.00  dated  July  5,  endorsed  by  WiUiam  Kaid, 
and  payable  at  the  Valley  Grove  National  Bank,  Valley  Grove, 
Mass.,  with  interest  at  8%. 

8  John  Weaver  buys  merchandise  to  the  amovmt  of  $500.00,  giving 

his  personal  note  for  60  days  at  8%,  payable  at  the  Valley 
National  Bank.  The  firm  immediately  discounts  the  note 
at  the  bank  at  6%. 

9  The  firm  receives  of  J.  C.  Jackson  his  30-day  note  for  $300.00, 

dated  July  5,  payable  at  the  Johnson  City  State  Bank,  Johnson 
City,  Pa.,  with  interest  at  6%,  in  full  settlement  of  his  account. 
10    Post  the  entries  to  date,  and  close  the  bill  journal. 

2.  State  how  the  transactions  in  Problem  i  would  have  been  treated 
both  in  the  original  entries  and  in  the  ledger  if  the  bill  book  had  been  used 
simply  as  a  memorandum  book  and  not  as  a  subsidiary  journal. 


CHAPTER  XVII 
TRANSACTIONS  FOR  FEBRUARY 

1.  Materials  Required  for  the  February  Transactions.  —  The 
following  kinds  of  paper  will  be  required  for  the  February 
transactions: 

a.  About  eight  sheets  of  columnar  journal  paper,  pp.  1-16. 

b.  About  six  sheets  of  columnar  journal  paper,  pp.  1-12. 

c.  One  sheet  of  register  paper  for  purchase  register,  pp.  1-2. 

d.  A  second  sheet  of  register  paper  for  returns  and  allowances 

on  purchases,  pp.  1-2. 

e.  One  sheet  of  register  paper  for  a  sales  register,  pp.  1-2. 

f.  A  second  sheet  of  register  paper  for  returns  and  allowances 

on  sales,  pp.  1-2. 

2.  Ledger  for  New  Set.  —  The  ledger  will  be  divided  into 
the  following  ledgers:  general  ledger,  purchase  ledger,  and 
sales  ledger.  The  accounts  and  pages  for  the  general  ledger 
(February  accounts)  are  as  follows: 


A.    Assets 
Current  Assets 

Ledger  page 

a.  Cash  (see  Cash  Journal) 
Petty  Cash 

b.  Notes  Receivable 

I 
I 

(i)  Notes  Receivable  Disc,  (deduction) 
c.    Accounts  Receivable 

2 

2 

(i)  Reserve  for  Bad  Debts 

3 

d.  Merchandise  Inventory — Carpets 

e.  Merchandise  Inventory  —  Furniture 

f.  Scrap 

g.  Accrued  Accounts  Receivable 

3 

4 
4 
5 

Working  Assets 

a.  Insurance  Unexpired 

b.  Supplies  Inventory 
Fixed  Assets 

S 
6 

a.   Land 

6 

b.  Buildings 

(i)  Depreciation  Reserve  for  Buildings 

c.  Delivery  Equipment 

(i)  Depreciation  Reserve  for  Del.  Equipment 

8 
8 
9 
9 

TRANSACTIONS   FOR   FEBRUARY  223 

A.    Assets  —  Contin ucd 

Furniture  and  Fixtures  —  Administration  10 

(i)  Depreciation  Reserve  for  Furniture  and 

Fixtures  —  Administration  10 

Furniture  and  Fixtures  —  Selling  1 1 
(i)  Depreciation  Reserve  for  Furniture  and 

Fixtures  —  Selling  1 1 


B.    Liabilities 

Current  Liabilities 

a.    Notes  Payable 

12 

b.   Accounts  Payable 

12 

c.    Accrued  Accounts  Payable 

13 

Deferred  Income 

13 

Proprietorship 

a.    Frank  Williams,  Capital 

13 

b.  Frank  Williams,  Personal 

14 

c.    Walter  Day,  Capital 

14 

d.   Walter  Day,  Personal 

15 

C.    Revenue  Accounts 

Income  Accounts 

a.  Furniture  Sales  17 

(i)  Returns  and  Allowances  on  Furniture 

Sales  18 

b.  Carpet  Sales  18 

(i)  Returns  and  Allowances  on  Carpet  Sales  19 

c.  Other  Income 

(i)  Discount  on  Purchases  19 

(2)  Interest  Earned  20 
Expense  Accounts 

a.  Furniture  Purchases  21 

(i)  Returns  and  Allowances  —  Furniture  Pur.  21 

b.  Carpet  Purchases  22 

(i)  Returns  and  Allowances  —  Carpet  Pur.  22 

c.  Freight  In  23 

d.  Administrative  Expenses 

(i)  Administrative  Salaries  23 

(2)  Depreciation  of  Furniture  and  Fixtures  — 
Administration  24 

(3)  Administrative  Miscellaneous  24 

e.  Selling  Expense 

(i)  Freight  Out  25 

(2)  Advertising  25 

(3)  Sales  Salaries  26 


224  ACCOUNTING  PRINCIPLES 

C.    Revenue  Accounts  —  Continued 

(4)  Depreciation  of  Furniture  and  Fixtures  — 
Selling  26 

(5)  Miscellaneous  Selling  Expense  27 
^  (6)  Losses  from  Bad  Debts  27 

(7)  Collections  and  Exchange  27 

f.  Deliverj-  Expense 

(i)  Op)eration  of  Auto  Truck  28 

(2)  Operation  of  Wagon  Truck  28 

(3)  Depreciation  on  Delivery  Equipment  29 

(4)  Miscellaneous  Delivery  Expense  29 

g.  Biiilding  Expense 

(i)  Depreciation  of  Building  30 

(2)  Repairs  of  Building  30 

(3)  Heat  and  Light  31 
h.   Deductions  from  Income 

(i)  Interest  Expense  31 

(2)  Discoimt  on  Sales  32 
g.    General  Expense 

(i)  Expired  Insvirance  33 

(2)  Losses  from  Sale  of  Fixed  Assets  33 

(3)  Miscellaneous  33 

D.    Closing  Accounts 

1.  Trading 

2.  Profit  and  Loss 

An  index  should  be  inserted  at  the  beginning  of  the  general 
ledger  and  all  accounts  should  be  indexed  as  they  are  entered. 

The  purchase  ledger,  which  follows  the  general  ledger, 
should  contain  all  the  accounts  payable  arising  out  of  pur- 
chases. An  index  sheet  should  be  inserted  at  the  beginning  and 
three  account  pages  should  be  inserted  and  paged  consecutively 
as  they  are  needed. 

The  sales  ledger  should  be  constructed  in  the  same  way  as 
the  purchase  ledger. 

3.  New  Firm  Organized.  —  A  new  firm,  Williams  and  Day, 
is  constituted  to  take  over  the  business  of  the  Valley  Furniture 
Store  owned  by  Frank  Williams.  It  is  agreed  that  profits  and 
losses  are  to  be  shared  equally  by  the  partners. 

4.  Transfer  to  the  New  Finn  the  Business  of  the  Valley  Fur- 

*  Losses  from  Bad  Debts  would  be  charged  against  a  credit  and  collection  department  if 
there  existed  such  an  adminbtrative  division. 


TRANSACTIONS  FOR  FEBRUARY         225 

nitiire  Store.  —  From  the  Balance  Sheet  of  the  Valley  Furni- 
ture Store  as  shown  by  the  closing  entries  for  January,  or  by  a 
post-closing  trial  balance,  make  journal  entries  transferring  the 
business  to  Williams  and  Day  and  make  the  final  closing  en- 
tries in  the  ledger  of  the  January  books. 

5.  Make  Opening  Entries  Taking  Over  Business  of  Valley 
Furniture  Store.  —  Now  make  the  opening  entries  in  the  Feb- 
ruary books  required  to  place  on  the  books  the  assets  and  lia- 
bilities taken  over  from  the  Valley  Furniture  Store  owned  for- 
merly by  Frank  Williams,  who  is  given  a  capital  interest  in  the 
new  firm  equal  to  the  capital  shown  on  the  books  of  the  Valley 
Furniture  Store  at  the  close  of  business  January  31. 

6.  Taking  Over  the  Business  of  Walter  Day.  —  The  business 
of  Walter  Day  is  taken  over  on  the  basis  of  the  Balance  Sheet 
of  January  31  as  follows: 


WALTER  DAY 

Balance  Sheet, 

January  31 

,  1914 

Assets 

Current  Assets: 

Cash 

Notes  Receivable  (dated  Jan. 

I,  1914,  due  Sept.  i,  1915, 

interest  7%) 
Accounts  Receivable: 

1,500. 
500. 

00 
00 

George  Carey 

J.  Collins 

Fulton  Furniture  Co. 

700.00 
385.00 
650.00 

Martindale  Furniture  Co. 

1,350.00 

A.  W.  Martin 

375-00 

Randolph  Furniture  Co. 
K.  C.  Riley 

1,075.00 
150.00 

Merchandise  Inventory 

Accrued  Accounts  Receivable  Interest 

4,685. 

25,000, 

2. 

00 
.00 

l2£ 

Deferred  Expense: 

Insurance  (expiring  Jan.  i,  1917) 
Fixed  Assets: 

31,687. 
200. 

.92 
00 

Delivery  Equipment 

2,000. 

00 

Total  Assets 

33.887. 

.92 

226  ACCOUNTING   PRINCIPLES 

Liabilities 
Current  Liabilities: 
Notes  Payable: 
Page  Furniture  Co.  (Note  dated  Dec.  i, 
1913,  due  May  30,  1914,  interest  8% 
payable  at  maturity.)  2,500.00 

John  Smith  (dated  Nov.  i,  1913,  due 
April  30,  1 914,  interest  at  8%  payable 
at  maturity.)  3,500.00 

Accounts  Payable: 
Limbert  &  Gray  Furniture 

Co.  1,800.00 

Tobey  Furniture  &  Carjiet 

Co.  1,650.00 

Lacy  Lock  &  Safe  Co.  200 .  00 

Haywood  Furniture  Co.  235.00 

3,885  00 
Accrued  Accounts  Payable: 
Interest  104 .  67 


9,989.67 

23,^98.20 
Total  Liabilities  33.887 .  92 


Proprietorship: 
Walter  Day,  Capital  23,^98 .  20 


7.  Readjusting  the  Inventories.  —  In  the  February  books, 
the  following  accounts  are  to  be  substituted  for  the  merchan- 
dise purchases,  the  merchandise  sales,  and  the  merchandise 
inventory:  furniture  purchases,  carpet  purchases,  furniture 
sales,  carpet  sales,  merchandise  inventory  —  carpets,  merchan- 
dise inventorv'  —  furniture.  Of  the  merchandise  turned  over  by 
the  Valley  Furniture  Store,  $4,500  is  carpets  and  the  remainder 
is  furniture.  Of  the  merchandise  turned  over  by  Walter  Day, 
$10,000.00  worth  is  carpets  and  $15,000.00  furniture. 

8.  Petty  Cash  Book.  —  Petty  cash  is  to  be  entered  in  a 
memorandum  Petty  Cash  Book  ruled  as  indicated  in  Illustra- 
tion No.  13. 

9.  Note  Journal.  —  The  book  for  notes  payable  and  notes 
receivable  will  be  kept  as  a  journal.  The  student  will  rule 
paper  to  be  used  for  the  journal  in  accordance  with  Illustration 
No.  23  and  23  A. 


TRANSACTIONS  FOR  FEBRUARY         227 

Feb.  I.  Williams  and  Day  borrow  by  discounting  the  firm's  note 
of  $5,000.00  at  8%  for  90  days,  at  the  Valley  National  Bank.  Ac- 
counts are  paid  as  follows: 

Check  #1,  Wilson  Carpet  Co.  2,100.00 

Check  #2,  Haywood  Furniture  Co.  2,000.00 

Check  #3,  Lacy  Lock  &  Safe  Co.  150.00 

Check  #4,  Sample  Furniture  Co.  37  00 

Check  #5,  Underwood  Typewriter  Co.  102 .  50 


Discounts  were  taken  as  follows: 
Lacy  Lock  &  Safe  Co.,  2%. 


4,789-50 


Enter  the  total  of  each  bill  in  the  Accounts  Payable  column 
of  the  cash  book,  any  discounts  in  Discounts  on  Purchases,  and 
the  net  payments  in  Bank  Withdrawals. 

The  partnership  also  settles  with  the  contractors,  who  have  built 
additional  stcwrage  capacity  in  anticipation  of  the  partnership,  paying 
$500.00  cash  (check  #6)  and  making  a  $500.00  one-year  8%  note  to 
A.  J.  Hamburg,  contractor,  the  entire  cost  of  the  addition  being 
$1,00000.  (Charge  to  buildings.)  The  firm  also  receives  bills  for 
additional  stock  orders  in  anticipation  of  the  expansion  in  business. 
One  of  those  bills,  bearing  the  date  of  January  25,  1914,  was  for 
$1,500.00  of  rugs  and  carpets  from  the  Wilson  Carpet  Co.  and  pro- 
vided for  a  2%  discount  for  ten  days,  30  days  net.  The  bill  was 
checked  and  paid  (check  #7). 

Enter  the  purchase  in  the  purchase  register  as  invoice  No. 
I,  and  in  the  cash  book  also  referring  to  purchase  register. 

Feb.  2.  The  firm  decides  to  dispose  of  some  surplus  delivery 
equipment,  and  buy  one  automobile  truck  instead.  One  team  and 
two  trucks  costing  $1,800.00  are  sold  for  $1,650.00,  and  an  automobile 
truck  is  purchased  for  $2,000.00  (check  #8.)  ^ 

Bank  deposits  are  made  once  a  day.  This  is  the  only  receipt 
recorded  on  February  2.  Enter  the  amount  in  the  General  and 
in  the  Bank  Deposits  columns. 

In  order  to  enforce  a  plan  of  making  all  payments  by  check  and 
properly  checking  the  cash  balance,  it  was  decided  to  create  a  petty 

'  A  new  account,  losses  from  sale  of  fixed  assets,  might  be  opened  for  this  item. 


228  ACCOUNTING  PRINCIPLES 

cash  fund  of  $icx).oo,  and  check  #9  was  issued  to  the  cashier  for  this 
amount. 

One  team  is  kept  and  it  is  decided  to  carry  separate  accoimts, 
showing  the  cost  of  horse  food  and  repairs  and  upkeep  of  the  auto- 
mobile trtick,  naming  the  accounts  "operation  of  automobile  truck" 
and  "operation  of  wagon  truck."  The  firm  buys  10  gallons  of 
gasoline  for  $1.50  (petty  cash)  and  com  and  hay  costing  $20.00 
(petty  cash).  The  wagon  truck  is  repaired  at  a  cost  of  $15.00 
(petty  cash).  The  firm  also  buys  two  tons  of  fuel  for  $12.50  (petty 
cash).  The  firm  carries  no  separate  fuel  account,  preferring  to  charge 
such  items  to  "general  expense." 

Feb.  3.    The  firm  receives  cash  in  payment  of  accounts  as  follows: 


St.  Luke  Hospital 

660.00 

(2%  discount  being  taken  on  $160.00 

of  the 

amount.) 

Bagdad  University 

2 

50.00 

Rice  Mfg.  Co. 

300.00 

Smith  Institute 

600.00 

J.  H.  Brigham 

290.00 

[disc. 

on 

K.  C.  Riley 

500.00 

$235- 

00] 

H.  P.  Square  Business  College 

195.00 

Foster  Hall 

S500 

Randolph  Furniture  Co. 

1,075  00 

George  Carey 

700.00 

K.  C.  Riley 

150.00 

A.  W.  Martin 

37SOO 

Enter  the  amount  of  each  bill  in  Accounts  Receivable  and 
the  discounts  allowed  in  Discounts  on  Sales.  One  entry  for  the 
total  of  the  net  receipts  is  made  in  the  Bank  Deposits  column, 
since  all  money  received  on  February  3  is  deposited  at  one 
time. 

The  student  is  expected  to  refer  to  the  ledger  account  to  see 
if  discounts  are  allowed,  and  may  assume  that  all  discounts  are 
taken,  unless  otherwise  stated.  In  actual  operation,  the  firm 
would  refer  to  those  accounts  in  making  out  its  monthly  state- 
ment to  customers,  but  since  statements  are  not  made  out  here, 
we  shall  assume  the  firm  to  receive  the  cash  over  the  counter 
or  in  each  case  to  figure  the  allowable  discounts  from  its  ledger 
accounts.  For  these  transactions  the  student  may  further  as- 
sume that  the  customer  gets  a  discount  on  such  amounts  as 


TRANSACTIONS  FOR  FEBRUARY         229 

may  be  applied  on  accounts  subject  to  discount  even  if  the 
payment  does  not  cover  all  of  such  an  account. 

Feb.  3.  W.  M.  Day  fails  in  business  and  his  accoimt  of  $45.00  is 
marked  off  as  an  absolute  loss. 

The  student  should  charge  this  to  reserve  for  bad  debts. 
The  account  is  debited  for  all  losses  on  bad  debts. 

Be  sure  that  the  debit  and  credit  items  are  carried  into  the 
proper  columns. 

The  cash  sales  for  the  last  three  days  of  the  week  were  as  follows: 
Carpets  180.00 

Furniture  225.00 

Less  frequent .  records  are  made  in  this  business  to  shorten 
the  routine  work.  The  evidence  of  receipts  from  cash  sales  is 
supplied  in  the  business  by  cash  register  slips,  which  are  filed. 
The  credit  sales  are  evidenced  by  duplicate  sales  sUps  as  usual. 


The  credit  sales  were  as  follows: 

Carpets: 

#1,  Foster  Hall 

50.00 

#2,  Smith  Institute 

85.00 

#3,  K.C.Riley 

30.00 

#4,  Randolph  Furniture  Co. 

125.00 

(2%  10  days,  net 

30) 

Furniture: 

#1,  Foster  Hall 

$30  00 

#2,  Randolph  Furniture  Co. 

150.00 

(2%  10  days,  net 

30) 

#5,  Martindale  Furniture  Co. 

75.00 

(2%  10  days,  net 

30) 

Credit  sales  are  entered  in  the  sales  register.  The  total  of 
each  sale  is  placed  in  the  amount  column  and  the  amount  of 
carpets  and  furniture  in  their  respective  columns.  Notice  that 
in  two  sales  both  carpets  and  furniture  are  involved. 

The  payroll  is  made  out  for  a  week,  the  accrued  wages  for  three 
days  of  January  being,  by  consent  of  the  partners,  charged  to  the 
February  account.  The  two  partners  agree  that,  since  they  are  to 
share  profits  equally,  they  will  draw  out  equal  amounts  of  $30.00 


230  ACCOUNTING  PRINCIPLES 

per  week  each  as  salaries  and  charge  these  amounts  to  the  salary 
accoxmt.  The  new  partner,  Walter  Day,  takes  a  salary  for  only 
three  days,  or  $15.00,  so  that  the  salary  payment  for  the  week  is  as 
follows  (check  #10) : 


Frank  Williams,  Partner 

$30.00 

Walter  Day,  Partner 

15.00 

H.  P.  McCullough,  Salesman 

25.00 

Floyd  Jones,  Clerk 

12.00 

R.  P.  Ranger,  Driver 

10.00 

J.  E.  Smith,  Chauflfeur 

10.00 

$102.00 

The  above  payroll  is  the  regular  weekly  payroll  except  that  Walter 
Day's  regular  salary  is  $30.00  per  week. 

February  5.     Bills  for  goods  ordered  were  approved  as  follows: 

Invoice  #2,  Wilson  Carpet  Co.  for  rugs  and  caqiets       500.00 

Invoice  #3,  Sample  Furniture  Co.  for  furniture         2,500.00 

(Each  bill  was  2%  10  days,  net  30) 

February  8.  H.  R.  Scott  makes  a  60-day  note  bearing  8%  for 
$428.00  in  settlement  of  his  account.  The  firm  makes  a  sixty-day 
8%  note  in  settlement  of  its  account  of  $1,800.00,  with  the  Limbert 
&  Gray  Furniture  Co.  The  firm  pays  a  bill  of  $50.00  to  the  Trihiitie 
for  advertising  (check  #11).  It  also  pays  a  bill  from  the  Capital 
Garage  for  $10.00  for  repairs  on  the  automobile  (check  #12). 

K.  C.  Riley  returns  a  $30.00  rug  delivered  to  him  Feb.  4th.  The 
Randolph  Furniture  Co.  's  allowed  a  rebate  of  $10.00  for  damages  of 
its  shipment  of  furniture  purchased  Feb.  4th. 

(A  sales  returns  and  allowances  book  is  ojjened  on  a  sheet  of 
the  sales  register  paper.  Entries  in  this  book  are  made  just 
like  entries  in  the  sales  register.  The  p>ostings  will,  of  course, 
be  reversed.  To  distinguish  the  book  from  the  sales  register, 
the  headings  are  written  in  red.) 

February  9.  On  account  of  an  increase  in  stock  and  additions  to 
bxiilding,  the  firm  took  out  additional  fire  insurance  to  the  amount  of 
$25,000.00  for  three  years,  paying  a  premium  of  $360.00  (check  #13). 
The  Capital  Garage  rent  for  February  was  paid  in  advance,  the 
amount  being  $10.00.  A  new  extra  tire  of  the  same  type  as  the 
original  tires  was  bought  for  the  automobile  from  the  Capital  Garage, 
the  cost  being  $18.00.  Additional  gasoline  to  the  amount  of  10  gal- 
lons at  15  cents  per  gallon  was  purchased  from  the  Capital  Garage 
(check  #14  pays  all  items). 


TRANSACTIONS  FOR  FEBRUARY  231 

February  10.  In  order  to  strengthen  the  firm's  credit  w ih  the 
bank  in  anticipation  of  loan  requirements,  it  was  decided  to  borrow 
$1,000.00,  thus  preventing  any  decrease  of  deposits  at  this  time,  and 
at  the  same  time  preparing  to  meet  the  larger  total  of  bills  at  the  end 
of  the  month.  A  $1,000.00  note  for  60  days  at  8%  was  made  and  the 
firm  was  credited  with  the  amount  less  bank  discount  of  8%.  (This 
discount  is  interest,  and  not  to  be  confused  with  discounts  on  pur- 
chases or  sales.) 

The  face  of  the  note  is  entered  in  the  general  column.  On 
the  line  next  below  the  interest  is  entered.  The  journalization 
of  the  interest  is  interest  Dr.  and  cash  Cr.  This  entry  is  ex- 
actly the  opposite  of  all  other  entries  on  the  debit  side  of  the 
cash  book.  To  prevent  confusion  in  posting,  the  entry  is  made 
in  red  ink.  The  net  cash  proceeds  of  the  note  —  the  face  less 
the  interest  —  are  entered  in  the  Bank  Deposits  column. 

An  order  of  goods  was  received  from  the  Haywood  Furniture  Co., 
totaling  as  follows: 

Invoice  #4,  Rugs  and  Carpets  1,000.00 

Invoice  #4,  Furniture  3,500.00 

Returns  were  made  as  follows: 

Rugs  and  Carpets  50.00 

Furniture  25.00 

There  was  also  an  allowance  of  $30.00  for  damages  <.o  furniture  in 
transit. 

Returns  and  allowances  are  kept  both  for  purchases  and 
sales,  one  account  for  returns  and  allowances  on  purchases,  and 
one  for  returns  and  allowances  on  sales.  Open  a  purchase  re- 
turns and  allowances  book  similar  to  the  sales  returns  and 
allowances. 


The  Sales  for  the  week  were  as  follows: 

Cash  sales: 

Carpets 

250.00 

Furniture 

400.00 

Credit  sales: 

#6,  Fulton  Furniture  Co.      Carpets  and  rugs 

125.00 

Furniture 

17500 

(2  /  10  days,  net  /  30) 

#7,  J.  Collins                         Rugs 

45.00 

#8,  K.  C.  Riley                     Furniture 

3500 

#9,  A.  W.  Martin                  Furniture 

65.00 

232  ACCOUNTING  PRINCIPLES 

The  firm  paid  its  bills  approved  February  5  for  $500.00  and 
$2,500.00,  taking  advantage  of  the  discounts  (checks  15  and  16). 

The  weekly  payroll  was  also  paid  (check  #17). 

Frank  Williams  cashed  his  personal  check  for  $25.00  from  the  re- 
ceipts from  sales.  A  customer,  K.  C.  Riley,  also  secures  $30.00  in 
currency  from  the  receipts  from  sales  in  exchange  for  his  personal 
check  for  the  same  amount. 

February  12.  The  cashier  paid  an  express  bill  of  $5.00  from  petty 
cash. 

There  was  also  paid  from  the  petty  cash  fimd  $2.00  for  typewriter 
repairs,  and  $5.00  for  resetting  of  shoes  on  the  horses. 

February  13.  The  Randolph  Furniture  Company  settles  its  ac- 
count of  $265.00,  taking  the  discount. 

February  14.  The  note  in  favor  of  the  Sample  Furniture  Co.  due 
on  February  14,  is  paid  today  by  check  #18. 

Freight  on  goods  received  on  invoices  1-4  is  paid  by  check  #19  to 
the  Valley  Central  Railroad,  $190.00.     (Freight-In.) 

Walter  Day  takes  from  stock  a  rug  costing  $38.00  (Record  this 
transaction  in  the  journal.  Walter  Day's  accoimt  is  in  the  general 
ledger,  hence  the  entry  is  made  in  the  General  colunrn.) 

Check  #20  for  $25.00,  payable  to  Mrs.  Frank  Williams,  is  charged 
as  an  advance  of  salary  to  Frank  Williams. 

February  15.  A  contract  is  made  with  the  Oakley  Elevator  Co. 
for  the  installation  of  a  freight  elevator  in  the  building  to  cost  $350.00. 
Payment  of  $100.00  is  made  by  check  #21  at  this  time;  the  balance  is 
to  be  paid  on  completion  of  the  work.  During  the  night  a  thief 
rifled  the  safe  and  secured  the  amount  of  the  petty  cash  fund  on  hand, 
$39.00.  A  check,  #22,  is  made  to  replace  the  stolen  money  in  the 
petty  cash  fund. 

This  theft  is  an  unusual,  unforeseen  loss  and  should  be 
charged  to  general  expense  —  miscellaneous. 

February  16.  Rep>airs  on  the  safe  (General  Expense)  costing 
$25.00  are  made  by  the  Lacy  Lock  and  Safe  Co.  on  accoimt.  To 
prevent  a  recurrence  of  the  theft  a  burglar  alarm  system  costing 
$150.00  is  purchased  from  the  Lacy  Lock  and  Safe  Co.  on  account. 
(Since  this  is  not  a  purchase  of  merchandise,  it  is  recorded  in  the 
Joiu"nal  and  not  in  the  Purchase  Register.  Be  sure  that  the  items 
appear  in  the  proper  colunms.) 

The  firm  joins  the  Merchants'  Mutual  Protective  Association,  pay- 
ing $10.00  in  advance  for  watchman's  service  (check  #23). 

February  17.  A  check,  #24,  for  $25.00,  is  drawn  payable  to  the 
Valley  Commercial  Club  as  a  contribution  toward  bringing  a  conven- 
tion to  the  city. 


TRANSACTIONS  FOR  FEBRUARY 


233 


Checks  in  payment  of  account  are  received  as  follows: 

J.  Collins,  $75.00. 

Fulton  Furniture  Co.,  $200.00  to  apply  on  old  account. 
The  weekly  payroll  is  paid  with  check  #25.     (Remember  the  ad- 
vance made  on  the  14th.) 
Cash  sales  for  the  week: 


Furniture 

$350 

.00 

Carpets 

285. 

.00 

Credit  sales: 

Customer 

Furniture 

Carpets 

Terms 

Rice  Mfg.  Co. 

74.60 

2/10,  n/30 

Smith  Institute 

51.20 

"20.00 

(<             a 

J.  H.  Brigham 

34.00 

26.00 

a            u 

H.  P.  Square  Business 

CoUege 

95.00 

30.00 

It                 Cl 

H.  R.  Scott 

73 -40 

a            It 

Wm.  Wood 

60.00 

ti             It 

A.  W.  Martin 

23.20 

60.60 

It             t( 

Randolph  Furniture  Co. 

103.00 

20.00 

It             ft 

K.  C.  RUey 

37.10 

It             tt 

Purchases: 

Creditor: 

Wilson  Carpet  Co. 

60.00 

75.00 

«             (( 

Limbert  &  Gray  Furni- 

ture Co. 

60.00 

((             « 

Tobey  Furniture  &  Car- 

pet Co. 

40.00 

50.00 

((             (( 

February  19.  The  check  of  J.  Collins  deposited  on  the  seven- 
teenth is  returned  dishonored  because  of  insufficient  fimds.  Check 
#26  is  drawn  in  favor  of  the  National  Bank  to  make  good  the  amount 
and  notice  of  the  failure  to  collect  the  check  is  sent  to  J.  Collins. 

A  dishonored  check  is  charged  back  to  the  account  of  the 
person  from  whom  it  is  received. 

An  order  is  received  from  J.  H.  Hotchkiss  of  Ft.  Green  for  carpets, 
$150.00.  Since  the  firm  has  no  information  regarding  his  credit 
standing,  Mr.  Hotchkiss  agrees  to  have  the  goods  shipped  to  him 
C.  O.  D.  (Collect  on  Delivery). 

When  a  C.  O.  D.  sale  is  made,  the  transportation  company 
collects  for  the  goods  on  delivery  and  remits  the  amount.    A 


234  ACCOUNTING  PRINOPLES 

collection  charge  is  made  for  this  service.  C.  O.  D.  sales  are 
not  charged  to  the  persons  buying  the  goods,  but  to  a  C.  O.  D. 
account,  the  name  of  the  customer  being  written  in  the  expla- 
nation space.  When  the  remittance  is  received,  C.  O.  D.  is 
credited.  The  balance  in  C.  O.  D.  at  any  time  shows  the 
amount  outstanding  on  C.  O.  D.  account. 

Several  items  in  the  account  of  the  Martindale  Furniture  Co.  are 
long  overdue.  They  are  pressed  for  payment,  but  cannot  pay  cash. 
As  a  compromise,  three  notes  for  $500.00,  $500.00,  and  $350.00  at  30, 
60,  and  90  days,  respectively,  wthout  interest  are  accepted  in  pay- 
ment for  the  overdue  iteips. 

February  20.  A  C.  O.  D.  sale  of  furniture  is  made,  $76.40,  to 
Henry  Perkins  of  New-ton  Comers. 

J.  H.  Brigham  sends  word  that  in  his  bill  of  the  17th,  he  was  over- 
charged $4.25  on  furniture.  Investigation  shows  that  he  is  correct 
and  a  credit  memorandum  for  the  amoimt  is  sent  him. 

This  is  neither  a  return  sale  nor  an  allowance.  It  is  merely 
the  correction  of  an  error.    In  what  book  should  it  be  entered? 

February  2 1 .  Feed  amounting  to  $20.85  is  bought  from  the  Central 
Produce  Company  (check  #26). 

Stationery  and  oflBce  supplies  amoimting  to  $34.68  are  purchased 
from  the  Comer  Book  Store  on  accoimt. 

J.  Collins,  whose  check  of  the  17th  was  returned  dishonored,  sends 
a  second  check  with  assurance  that  it  will  be  honored. 

Februar>'  23.  The  Fulton  Furniture  Co.  sends  a  check  in  payment 
of  their  account  of  $300.00.  The  Newsome  Furniture  Co.  of  Hixton 
offers  to  buy  a  bill  of  goods  providing  transportation  charges  to  Hix- 
ton are  paid. 

As  the  account  seems  to  be  a  profitable  one,  arrangements  are  made 
to  sell  them  furniture  $125.00  and  carpets  $68.00  f.  o.  b.  Hixton. 
(Free  on  Board  —  that  is,  the  vender  pays  all  charges  to  Hixton.) 
The  terms  of  the  sale  are  regular.  A  check  is  made  out  to  the  Valley 
Central  Railroad  for  $11.50  freight  charges  (Freight-Out.)  (Check 
#28.) 

The  remittance  for  the  C.  O.  D.  sale  of  the  19th  is  received. 

Collection  charges  of  $0.85  are  paid  in  cash  from  the  petty  cash 
fund. 

February  24.  A  storm  damages  the  store  building  to  the  extent  of 
$150.00  and  the  stock  of  fumiture  to  the  extent  of  $100.00.  A  con- 
tract for  repairs  to  the  building  is  let  to  J.  R.  Gross  for  $150.00.     (No 


TRANSACTIONS  FOR  FEBRUARY  235 

entry  at  this  time.  Why  not?)  The  damages  to  the  stock  cannot 
be  repaired. 

(This  stock  damage  is  an  expected  loss.  The  value  of  the  mer- 
chandise inventory  of  furniture  has  been  decreased  by  the  amount 
of  damage.) 

The  remittance  for  the  C.  O.  D.  sale  of  the  20th  is  received. 

The  30-day  note  of  the  Martindale  Furniture  Co.  dated  the  igth  is 
discounted  at  the  bank  at  6%  (six  per  cent)  and  the  proceeds  placed 
to  the  credit  of  WiUiams  and  Day. 

To  show  the  contingent  liability  on  a  discounted  note  the 
face  of  the  note  is  credited  to  notes  receivable  discounted  in- 
stead of  to  notes  receivable.  Interest  is  debited  for  the 
amount  of  the  discount  and  the  bank  for  the  net  proceeds. 
For  convenience  in  auditing,  the  debt  to  interest  is  made  in 
red  ink  in  the  General  column  on  the  debit  side  of  the  cash  book. 

The  weekly  payroll  is  paid  with  check  #29.  No  deductions  are 
made  on  account  of  the  holiday. 

Cash  sales: 

Carpets  $225.00 

Furniture  375  00 

Credit  sales: 

Customer  Furniture  Carpets             Terms 

St.  Luke  Hospital  $175.00  $125.00 
Randolph  Furniture 

Co.  225.00  40.00          2/iOj  n/30 

George  Carey  34  00  66.00 

A.  W.  Martin  70.00  80.00 

A.  M.  Mastin  80.00 

K.  C.  Riley  85.00  65.00          2/10,  n/30 

Hotel  Bismarck  125.00  7Soo 

Purchases: 

Creditor 
Tobey   Furniture    & 

Carpet  Co.  225.00  160.00  2/10,  n/30 

Wilson  Carp>et  Co.  70.00  "         " 

Haywood    Furniture 

Co.  125.00 

The  Western  Union  collects  a  bill  of  $15.50,  which  is  paid  from 
petty  cash. 

February  26.  The  bookkeeper  discovers  that  the  sale  charged  to 
A.  W.  Martin  on  the  17th  should  have  been  charged  to  A.  M.  Mastin. 


236  ACCOUNTING  PRINCIPLES 

Interest  on  a  note,  the  personal  property  of  Frank  Williams,  is 
collected  and  deposited  with  the  funds  of  the  firm.     Amount  $25.00. 

A  bill  of  the  Central  Garage  for  $36.00  is  paid  with  check  #30. 
$16.00  of  this  amount  is  for  supplies  for  the  truck  and  $20.00  for 
repairs  to  Walter  Day's  car. 

The  elevator  installation  is  completed.  A  check  (#31)  is  sent  the 
Oakley  Elevator  Co.  for  the  amount  due  them. 

The  60-day  note  of  the  Martindale  Furniture  Co.  is  discounted  at 
the  bank  at  6%. 

A  bill  of  carpets,  $70.00,  and  furniture,  $123.50,  is  sold  to  the 
Newsome  Furniture  Co.,  f.  o.  b.  Hixton,  the  terms  regular. 

February  27.     Customers  pay  their  accounts  as  follows: 

Randolph  Furniture  Co.  $123.00 

(Discount  taken  whenever  possible) 
Rice  Mfg.  Co.  74 .  60 

W.  Wood  1 1 5  •  00  (Discount  on  $60.00) 

K.  C.  Riley  72.10  (Discount  on  $37.10) 

February  28.  The  repairs  on  the  store  building  are  completed  and 
a  check  (#32)  is  given  J.  R.  Gross  in  payment  for  the  contract  price. 

A  check  (#33)  is  given  the  Valley  Central  Railroad  in  payment  of 
freight  bills.  $9.60  is  for  freight  on  the  Newsome  Furniture  Co. 
shipment  of  the  25th  and  $24.68  for  freight  on  goods  received. 

Walter  Day  takes  from  stock  a  table  costing  $17.50.^ 

Apply  payments  on  earliest  bills  unless  otherwise  directed. 

A  C.  O.  D.  sale  of  carpets,  $42.35,  is  made  to  Peter  Wilson  of  Pine 
Grove. 

The  bookkeeper  reports  petty  cash  expenditures  as  follows: 


Express  (Freight-In) 

$500 

Collection  and  Exchange 

.85 

General  Expense 

30.00 

Operation  of  Horse  Truck 

40.00 

Operation  of  Auto  Truck 

1 .  50 

$77-35 

He  is  given  a  check  (#34)  to  reimburse  the  fund  for  these  payments. 
Payments  on  accoimt  as  follows:  (Take  discount  whenever  possible) 


Tobey  Furniture  Co. 

$90.00 

(#35) 

Limbert  &  Gray  Furniture  Co. 

60.00 

(#36) 

Wilson  Carpet  Co. 

75.00 

(#37) 

Haywood  Furniture  Co. 

2,000.00 

(#38) 

Lacy  Lock  &  Safe  Co. 

225.00 

(#39) 

'  Charge  Walter  Day,  personal,  and  credit  furniture  purchases. 


TRANSACTIONS  FOR  FEBRUARY         237 

A  cash  customer  is  refunded  $3.30  (check  #40)  for  a  rug  returned 
(enter  in  cash  book). 

A  carpet  is  returned  to  the  Tobey  Furniture  &  Carpet  Co.  for 
credit  $32.50.  Claim  against  the  Haywood  Furniture  Co.  for  damages 
of  $8.75  in  recent  furniture  shipment  is  allowed  and  credit  memo- 
randum received. 

K.  C.  Riley  is  allowed  $6.00  for  imperfections  in  furniture  delivered. 

George  Carey  returns  a  rug  for  credit,  $24.00. 

POST  TRIAL   BALANCE   CLOSINGS 

1.  Directions  for  closing  the  February  Books: 

a.  Defer  the  interest  paid  in  advance,  and  insurance. 

b.  Depreciate  the  delivery  equipment  by  allowing  2  per 

cent  for  the  month. 

c.  Other  depreciation  charges  for  the  month  are: 

Building,  3^  of  i  per  cent;  store  and  office  fixtures, 
2  per  cent. 

d.  Make  the  necessary  entries  to  place  on  the  books  in- 

terest accrued  on  both  notes  receivable  and  notes 
payable  as  shown  by  the  notes  in  the  note  journal. 

e.  The  bill  for  $150.00  for  building  repairs  paid  to  J.  R. 

Gross  on  Feb.  28  should  be  distributed  over  12 
months,  beginning  with  February.  An  account 
of  repairs  on  building  is  opened.  Make  neces- 
sary entries. 

f.  In  order  to  allow  for  the  accrued  wages,  it  is  necessary 

to  allow  $58.50  ($5.00  operation  of  auto  truck; 
$5.00  wagon;  $48.50  salary)  for  this  item. 

2.  Close  the  returned  sales  and  allowances  and  the  purchase 

returns  and  allowances  and  other  appropriate  accounts 
in  the  trading  account. 

3.  Close  the  trading  into  the  profit  and  loss. 

4.  Close  all  accounts  going  to  profit  and  loss  into  this  account 

and  close  this  account  into  the  capital  accounts. 

5.  Close  any  personal  accounts  into  the  appropriate  capital  ac- 

counts. 

6.  Make  a  balance  sheet  according  to  Illustration  No.  21. 


238  ACCOUNTING  PRINCIPLES 

7.  Make  a  Revenue  Statement  in  the  form  indicated  in  Elus- 

tration  No.  16. 
Inventories  at  end  of  period: 

Furniture  Inventory  $37,422.10 

Carpets  Inventory  16,286.07 


CHAPTER  XVIII 

CLOSING  THE  BOOKS  FOR  PERIODICAL  REPORTS 

I.  The  Use  and  Limitations  of  the  Trading  Account.  —  Pur- 
chases, sales,  sales  returns  and  allowances,  purchase  returns 
and  allowances,  freight-in,  merchandise  inventory  at  the  be- 
ginning of  the  period  and  merchandise  inventory  at  the  end  of 
the  period  can  all  be  closed  into  the  trading  account  by  means 
of  two  compound  journal  entries.  The  current  textbooks  are 
giving  preference  to  a  style  of  closing  which  avoids  the  use  of 
the  trading  account.  It  seems  worth  while  to  make  an  analy- 
sis of  the  comparative  efficiency  of  the  trading  account  method 
and  that  more  commonly  recommended  both  as  an  example  of 
accounting  analysis  and  for  the  practical  results  to  be  had 
from  the  analysis.  Let  us  make  the  closing  journal  entries  for 
the  trial  balance  on  the  next  page  as  they  affect  the  trading 
account  and  see  what  the  substitute  would  be  in  case  the  gener- 
ally preferred  method  were  employed: 


2.39 


240  ACCOUNTING  PRINCIPLES 

A.  P.  LINDSEY 
Trial  Balance,  December  31,  1920 

Cash 590.21 

Notes  Receivable 569.75 

Accounts  Receivable 8,275.46 

Merchandise  Inventory,  January  i,  1920  .  4,975.20 

Fiuniture  and  Fixtures 3,215.80 

Buildings 9,000.00 

Land 3,000.00 

Notes  Payable 2,192.67 

Accounts  Payable 5,460.75 

A.  P.  Lindsey,  Capital 20,000.00 

A.  P.  Lindsey,  Personal 1,701.09 

Sales 45,102.75 

Sales  Returns  and  Allowances    .     .     .      .  2,193.60 

Purchases 30,190.40 

Purchases  Returns  and  Allowances       .     .  2,970.80 

Inward  Freight  and  Drayage     ....  3,841.39 

Salaries 3,59067 

Advertising 1,140.75 

Insurance 316.00 

Light  and  Fuel 750.00 

Office  Supplies 250.30 

General  Exjjenses 1,590.55 

Royalties 100.00 

Discounts  on  Purchases 830.00 

Interest  Expense 225.80 

Discoiuits  on  Sales 1,240.00 

76.656  07       76.656  97 

Adjustment  Data,  December  31,  1920 

Merchandise  Inventory 5,190.34 

Office  Supplies  Inventory 50  ■  30 

Salaries  Accrued  and  Unpaid 100.00 

Advertising  Paid  in  Advance 215.25 

Unexpired  Insurance 75  40 

Interest  Accrued  on  Notes  Receivable 4°  ■  59 

Royalties  Received  in  Advance       .* 25.00 

Bad  Debts,  2%  of  Accounts  Receivable 
Depreciation: 

Buildings,  1% 

Furniture  and  Fixtures,  10% 


CLOSING  THE   BOOKS  FOR  PERIODICAL  REPORTS      241 

2.  Directions.  —  Set  up  the  accounts  on  ledger  paper,  making 
provision  for  valuation  accounts.  Next,  make  on  a  sheet  of 
journal  paper  the  necessary  adjusting  and  closing  entries,  and 
post  to  the  ledger  accounts.  Finally,  make  up  in  proper  form 
a  balance  sheet  and  profit  and  loss  statement. 

Journal  Closings  for  the  Trading  Account 

1.  Trading 60,500.00 

Merchandise  Inventory  Jan.  i,  1920  9,000.00 

Sales  Returns  and  Allowances     .      .  2,500.00 

Purchases 48,000.00 

Inward  Freight  and  Drayage      .      .  1,000.00 

2.  Merchandise  Inventory  —  end  of  period  16,211 .  50 

Sales 63,100.00 

Purchase  Returns  and  Allowances       .        3,000.00 

Trading 82,311.50 

3.  Trading — Gross  profit 21,811.50 

Profit  and  Loss  —  Gross  profit   .      .  21,811 .  50 

The  form  of  closing  which  is  more  generally  recommended 
for  the  accounts  concerned  would  require  the  following  journal 
entries: 

1.  Purchases 10,000.00 

Merchandise    Inventory  —  First    of 

period 9,000.00 

Inward  Freight  and  Drayage  1,000.00 

2.  Merchandise  Inventory  —  End  of  Period  16,211.50 
Purchase  Returns  and  Allowances       .        3,000 .  00 

Purchases 19,211.50 

3.  Sales 41,288.50 

Purchases  —  Cost  of  Sales     .     .     .  38,788.50 

Sales  Returns  and  Allowances    .     .  2,500.00 

4.  Sales  —  Gross  Profits 21,811.50 

Profit  and  Loss  —  Gross  Profits       .  21,811 .  50 

In  the  journal  entries  above  a  compound  entry  was  made 
when  it  was  feasible  to  do  so.  In  all  cases  where  a  compound 
entry  was  made  and  the  total  of  the  items  was  debited  or  cred- 


242  ACCOUNTING  PRINCIPLES 

ited  to  one  of  the  closing  accounts,  the  posting  to  the  closing 
account  is  made  in  detail  instead  of  in  total,  as  might  be  sup- 
posed from  the  appearance  of  the  journal  entry.  There  is  one 
more  journal  entry  pair  involved  when  the  sales  account 
is  substituted  for  the  trading  account,  but  the  substitution  is 
generally  preferred  mainly  on  the  ground  that  the  balances  of 
the  accounts  would  be  ready  for  use  in  making  the  revenue 
statement.  The  cost  of  sales  represents  the  item  which  the  sales 
account  method  of  closing  furnishes  that  must  be  separately 
calculated  when  the  closing  is  made  through  the  trading  ac- 
count. Of  course  the  regular  form  of  the  revenue  statement 
requires  the  use  of  the  items  involved  in  calculating  the  cost  of 
sales  so  that  no  more  work  is  involved  in  the  added  calculations 
made  in  the  purchases  account  when  it  is  closed  into  sales.  In 
fact  the  trading  account  serves  the  purpose  of  grouping  more 
items  which  are  taken  from  the  accounts  in  making  the  revenue 
statement.  In  making  the  revenue  statement  aU  the  items 
above  the  gross  profit  item  can  be  taken  from  the  trading  ac- 
count. Otherwise  it  is  necessary  to  refer  to  the  purchases  and 
the  sales  accounts  for  these  items.  There  is  possibly  a  sUght 
economy  involved  here  in  the  use  of  the  trading  account  al- 
though the  number  of  journal  items  is  the  same  in  each  of  the 
two  methods,  and  one  more  account  must  be  ruled  when  the 
trading  account  is  employed. 

There  is  doubtless  a  feeling  on  the  part  of  some  that  the 
analysis  involved  in  closing  through  the  sales  account  is  more 
readily  grasped  by  a  beginning  student  than  the  analysis  which 
is  necessary  in  explanation  of  the  trading  account.  This  may 
be  true  for  an  accounting  program  which  eliminates  the  mer- 
chandise account,  but  it  is  not  true  in  the  case  of  students  who 
have  already  learned  the  merchandise  account.  At  any  rate 
the  trading  account  analysis  is  not  difficult  for  a  college  student 
and  its  frequent  use  would  justify  teaching  it  even  if  it  were 
not  as  serviceable  as  the  sales  account  in  the  computation  of 
gross  profits. 

3.  The  Closing  Accounts.  —  When  the  closing  is  made  through 
the  trading  account,  the  closing  account  will  be  as  follows: 


CLOSING  THE  BOOKS  FOR  PERIODICAL  REPORTS      243 
Trading 


Mdse.  Inv.  Jan.  i,  1920 

9,000 .  00 

Sales                              63,100 

00 

Purchases 

48,000.00 

Purchases  Ret.  and 

Sales  Ret.  and  Allow. 

2,500.00 

Allow.                         3,000 

00 

Inw.  Frt.  and  Drayage 

1,000.00 

Mdse.  Inv.  Dec.  31, 

Gross  Profits 

21,811 .50 

1920                          16,211 

SO 

82,311.50 

82,311 

_5£ 

When  the  closing  is  made  through  purchases  and  sales  ac- 
counts^ the  two  closing  accounts  will  appear  as  follows: 

Purchases 


Purchases 

Mdse.  Inv.  Jan.  i,  1920 

Inward  Frt.  and  Dray. 


}.6,000.00 

9,000.00 
1,000.00 


58,000.00 


Purchase  Returns 
and  Allowances 

Mdse.  Inv.  Dec.  31, 
1920 

Cost  of  sales 


3,000.00 

16,211.50 

38.788.50 
58,000.00 


Sales 


Cost  of  sales  38,788 .  50 

Sales  Ret.  and  Allow.        2,500.00 
Gross  profits  21,811.50 


63,100.00 


Sales 


63,100.00 


63,100.00 


The  frequency  of  the  use  of  the  sales  account  in  closing  as  a 
substitute  for  the  trading  account  makes  it  necessary  for  the 
student  to  become  acquainted  with  the  procedure  involved  in 
such  cases.  There  is  not  a  great  deal  of  difference  in  the  time 
required  in  the  use  of  the  sales  and  trading  accounts  for  closing 
purposes,  and  little  can  be  said  in  favor  of  one  of  these  plans 
as  against  the  other. 

QUESTIONS  AND   PROBLEMS 

I.  Explain  the  procedure  involved  when  purchases  and  sales  accounts 
are  used  instead  of  trading. 


244  ACCOUNTING  PRINCIPLES 

2.  Make  the  journal  entries  for  closing  through  purchases  and  sales  for 
the  trial  balances  at  the  end  of  Chapter  XV. 

3.  (a)  How  many  additional  original  entries  are  required  over  those 
needed  in  the  case  of  the  use  of  the  trading  account? 

(b)  How  many  additional  postings? 

(c)  How  much  additional  ruling? 

4.  State  the  comparative  advantages  and  disadvantages  in  the  two 
methods  of  closing. 

5.  Make  the  adjusting  entries,  a  profit  and  loss  account,  and  a  revenue 
statement  and  balance  sheet  from  the  trial  balance  given  in  this  chapter, 
making  use  of  the  sales  accoimt  instead  of  the  trading  accoimL 


CHAPTER  XIX 
CONSIGNMENTS 

1.  Business  of  a  Consignee.  —  Instead  of  purchasing  all,  or 
sometimes  even  part,  of  his  stock  in  trade,  a  merchant  fre- 
quently acts  as  the  agent  of  another  in  the  sale  of  certain 
goods,  charging  a  commission  for  his  services.  Where  such  an 
arrangement  obtains,  the  goods  are  said  to  be  sold  on  consign- 
ment, the  owner  being  spoken  of  as  the  consignor  and  the  mer- 
chant as  the  consignee.  As  owner,  the  consignor  is  responsible, 
not  only  for  the  transportation  charges,  but  for  such  other  ex- 
penses as  may  be  incurred  in  connection  with  the  sale  of  the  goods 
consigned.  As  agent,  the  consignee  must  dispose  of  the  ship- 
ment in  accordance  with  the  terms  laid  down  by  the  consignor. 

2.  Consignee  Records.  —  Since  neither  the  assets  nor  the 
liabilities  of  the  consignee  are  affected  by  the  mere  arrival  of  a 
consignment,  no  journal  entry  is  made  at  the  time  the  goods 
are  received.  A  memorandum  record  is  necessary,  however,  to 
show  the  nature  and  amount  of  the  consignment  and  the  terms 
on  which  it  is  to  be  sold.  This  memorandum  record  may  be 
conveniently  entered  on  the  stub  of  an  account  sales  blank,  as 
indicated  in  Illustration  No.  25  below.  To  facilitate  the  jour- 
nal entries  to  be  later  made  on  the  books  of  original  record, 
each  consignment  should  be  given  a  specific  number  at  the  time 
it  is  received. 

In  recording  sales  of  consignment  goods,  two  possible  meth- 
ods present  themselves.  Under  the  first  method  both  the 
cash  and  the  credit  sales  may  be  entered  in  the  regular  sales 
journal  or  register,  which  is  provided  with  a  special  column 
for  the  purpose,  or  only  the  credit  sales  may  be  recorded  in 
the  sales  journal,  the  cash  sales  being  entered  in  the  cash 
book  and  posted  to  the  credit  of  the  respective  consignment 
accounts.     The  regular   account  space   of   the  sales  register 

24s 


246 


ACCOUNTING  PRINCIPLES 


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CONSIGNMENTS  247 

serves  for  the  entry  of  the  accounts  to  be  debited  in  connection 
with  the  various  consignment  sales,  the  consignments  to  be 
credited  being  indicated  in  a  column  to  the  right  of  the  coliunn 
for  consignment  sales.  In  other  words,  there  is  no  posting  of 
the  total  of  the  consignment  sales  column.  The  debits  for  the 
various  items  of  the  column  are  cash  and  individual  accoimts 
receivable,  the  corresponding  credits  being  the  respective  con- 
signment accounts.  The  illustration  on  the  opposite  page 
gives  the  correct  form  of  the  sales  register  above  described. 

There  is  an  alternative  which  would  eliminate  the  consign- 
ment sales  from  the  sales  journal,  the  time  sales  being  entered 
in  the  general  journal  and  the  cash  sales  in  the  cash  journal. 
This  method  is  used  in  Illustration  No.  26. 

Expenses  incurred  by  the  consignee  in  connection  with  con- 
signment goods  are  credited  to  cash  or  accounts  payable  and 
debited  to  the  consignment  accounts  to  which  they  pertain. 
The  consignee's  commission  is,  of  course,  also  charged  to  each 
consignment  account  and  credited  to  an  income  account  of 
commission  earned,  which,  when  the  books  are  closed  at  the 
end  of  a  particular  period,  is  closed  into  profit  and  loss  along 
with  the  other  revenue  items.  The  balance  of  the  consignment 
account  m.anifestly  represents  the  amount  due  to  the  consignor, 
and  is  ordinarily  paid  in  cash  at  the  time  the  accounting  to  the 
consignor  is  made. 

Since  the  commission  account  represents  the  total  income  of 
the  consignee  on  consignment  goods  and  the  sundry  expenses 
are  charged  to  the  consignor,  there  is  little  occasion  for  creating 
controlling  accounts  in  connection  with  recording  consignment 
data  on  the  books  of  the  consignee.  There  would  be  practi- 
cally no  managerial  significance  to  the  collection  in  one  total  of 
all  the  charges  made  in  connection  with  consignment  accounts, 
inasmuch  as  these  charges  affect  the  income  of  no  one  but  the 
consignor.  The  purpose  of  the  consignment  accounts  is  simply 
to  furnish  a  record  from  which  there  may  be  made  to  the  con- 
signor a  statement  of  the  gross  receipts  from  consignment  sales, 
the  charges  incurred  in  connection  therewith,  the  agent's  com- 
mission, and  the  balance  due  to  the  consignor  by  the  consignee. 


248  ACCOUNTING  PRINCIPLES 

As  an  illustration,  let  us  suppose  that  John  King  on  January 
I,  1919,  consigns  to  H.  P.  Woodrow,  of  Center,  111.,  fifty  bar- 
rels of  apples  to  be  sold  at  S5.00  a  barrel,  Woodrow  to  receive 
ten  per  cent  commission  for  his  services.  The  following  ex- 
penses are  incurred  by  Woodrow  in  connection  with  the  con- 
sigimient:  freight,  S20.00;  drayage,  $5.00.  On  January  15, 
1919,  Woodrow  renders  to  King  on  account  sales  with  check  for 
forty-nine  barrels  of  apples,  one  barrel  having  spoiled  after 
being  received.  The  journal  entries  required  to  record  on  Wood- 
row's  books  the  various  transactions  involved  are  as  follows: 

January  i 

Consignment  No.  i  (J.  R.  King)  —  Freight  20.00 

Consignment  No.  i  (J.  R.  King)  —  Drayage  5 .  00 

Cash  25.00 

Charges  incurred  in  receipt  of  50  barrels  of  apples 
from  John  King  to  be  sold  on  consignment. 

Cash  245.00 

Consignment  # I — Sales  245.00 

Goods  sold  on  consignment 

January  15 

Consignment  No.  i  —  Commission  24 .  50 

Commissions  —  Consignment  #1  24 .  50 

Commission  earned  on  Consignment  #1 

Consignment  #1  —  Balance  Due  Consignor  195  50 

Cash  195 . so 

Payment  of  balance  due  on  consignment 

After  these  journal  entries  are  posted  to  the  general  ledger, 
the  consignment  account  will  appear  as  follows: 

CONSIGNMENT  NO.  i  —  J.  R.  KING,  Consignor 

Sales  245 .  00 


I9I9 

1919 

Jan.     I     Freight 

20.00 

Jan.  15 

Drayage 

500 

15     Commission 

24  50 

Balance  Due 

Consignor 

195  50 

245  00  245 ■ 00 


CONSIGNMENTS  249 

Instead  of  sending  a  check  with  the  account  sales  for  the  bal- 
ance due  to  the  consignor,  Woodrow  might  have  credited  King 
with  the  amount  due.  The  consignment  account  would  then 
have  been  closed  with  the  following  journal  entry: 

Consignment  #1  —  Balance  Due  Consignor        iQS  •  50 
Account  Payable 

(John  King)  195 .  50 

Credit  to  King  of  balance  due  on  consignment 

An  account  sales  is  simply  a  summarized  statement  of  a  par- 
ticular consignment  account,  showing  the  consignment  sales, 
the  expenses  incurred,  the  commission  earned,  and  the  balance 
due  to  the  consignor.  As  the  account  sales  is  usually  made 
from  the  ledger  record,  the  consignment  account  should  show 
in  the  memorandum  space  the  data  set  forth  above. 

3.  Information  Required  by  the  Consignor.  —  Although  there 
is  no  change  of  ownership  when  the  consignor  ships  goods  to 
the  consignee  to  be  disposed  of  on  a  commission  basis,  it  is  de- 
sirable for  the  consignor  to  know  the  results  of  his  consign- 
ment business  not  only  as  regards  individual  consignees  but 
also  as  regards  the  consignment  business  as  a  whole.  He  must 
be  in  position  to  determine  whether  the  business  should  be  ex- 
panded or  contracted,  and  which  of  a  number  of  consignees 
should  be  encouraged  or  eliminated.  The  records  commonly 
kept  show  the  results  so  far  as  individual  consignees  are  con- 
cerned, but  are  deficient  in  supplying  information  with  refer- 
ence to  the  business  as  a  whole.  This  latter  information  may 
be  gained  through  controlling  accounts,  with  a  reduction  rather 
than  an  increase  in  the  labor  ordinarily  involved. 

4.  Consignee  Record  of  Shipments.  —  When  goods  are  sent 
to  a  consignee,  an  account  is  set  up  by  the  consignor  with  the 
consignment  in  question,  which  for  purposes  of  convenience  is 
designated  by  number.  The  account  is  debited  with  the  cost 
of  the  goods  shipped,  the  purchases  account  being  credited  for 
a  like  amount.  Thus  the  initial  step  is  taken  for  setting  up  a 
separate  profit  and  loss  accoimt,  which  is  later  closed  into  the 
regular  profit  and  loss.    By  means  of  controlling  accounts,  these 


2SO 


ACCOUNTING  PRINCIPLES 


ILLUSTRATION  NO.  25 
AcxrouNT  Sales 


No. 


Account  Sales  for  Consignment  No.  i  from     J.  R.  King 
Address      Valley,  111. 


50  barrels  of  apples 
$5.00  per  barrel 


Mdse.  Received 

Terms  of  Sale 

Commission 

Account  Sales  Rendered    January  15,  19 19 

Amount  Sold  49  barrels 

Deductions  i  barrel  spoiled  on  arrival 

Balance  Unsold  Carried  Forward  to  Account  Sales  No._ 

See  also  Account  Sales 


H.  P.  WooDROW,  Center,  111.,  Jan.  15,  19 19 
Accoimt  Sales  for  Consignment  No.  i  from     J.  R.  King 
Address    Valley,  111. 


Date 


Description 


1919 
Jan.  IS 


Sales  for  half  month 
Freight  .... 
Dray  age 
Commission 


20.00 

5.00 

24  50 


245  00 


49  5° 


195  SO 


The  stub  of  each  Account  Sales  should  contain  a  reference  to  all  preceding  account  sales 
affecting  a  given  consignment  number,  as  well  as  a  reference  to  the  account  sale  number  to 
which  the  balance  of  any  unsold  portion  of  a  consignment  may  be  carried. 


CONSIGNMENTS  251 

individual  shipment  profits  and  losses  may  be  combined  into  a 
single  shipment  profit  and  loss  account,  the  balance  of  which 
would,  of  course,  represent  the  total  of  the  balances  of  the  vari- 
ous subsidiary  shipment  accounts. 

To  illustrate  the  use  by  the  consignor  of  controlling  accounts 
in  connection  with  consignment  shipments,  let  us  consider  again 
the  fifty  barrels  of  apples  consigned  to  Woodrow  by  King,  sup- 
posing this  time  that  the  apples  cost  $150.00  and  that  the  freight 
and  drayage  are  paid  by  the  owner.  The  cost  of  the  shipment 
and  the  expenses  incurred  are  set  up  on  King's  books  by  the 
following  journal  entries,  which  contain  a  debit  first  to  the  con- 
trolling account  and  second  to  the  subsidiary  account,  written 
in  parentheses  underneath: 

January  i,  192 i 

Sh.  P.  and  L. —  Cost  of  Goods  Shipped      150.00 
(Shipment  No.  i,  —  H.  P.  Woodrow, 

Center,  111.)  ^ 

Purchases  150.00 

Shipment  of  50  bbls.  of  apples  to  H.  P. 

Woodrow  to  be  sold  at  $5.00  a  barrel 

on  10%  commission 

Sh.  P.  and  L. —  Shipment  Charges  — 
Freight,  $20.00;  drayage,  $5  25.00 

(Shipment  No.  i) 
Cash  25.00 

Payment    of    shipment    charges    ad- 
vanced by  Valley  Warehouse 

If  the  shipment  charges  had  been  credit  transactions,  the 
second  entry  would  have  been  as  follows: 

Sh.  P.  and  L. —  Shipment  Charges  — 

Freight,  $20.00;  drayage,  $5.00  25.00 

(Shipment  No.  i) 

Accounts  Payable  2  5 .  00 

(Valley  Warehouse) 
Credit  to  warehouse  of  shipment  charges 

advanced 

•  The  parenthesis  memorandum  indicates  in  each  case  the  subsidiary  account  debited  or 
credited. 


252  ACCOUNTING  PRINCIPLES 

The  journal  entries  connected  with  consignment  shipments 
are  most  advantageously  handled  through. a  shipment  journal, 
such  as  is  shown  in  Illustration  No.  26,  below.  Such  a  journal 
provides  for  all  the  data  involved,  except  shipment  charges 
which  are  paid  in  cash.  These  must  be  entered  on  the  credit 
side  of  the  cash  journal,  a  special  controlling  account  column 
being  added  for  these  items,  as  indicated  in  the  cash  journal 
illustrated  below. 

5.  Recording  the  Data  from  the  Account  Sales.  —  Upon  re- 
ceipt of  an  account  sales  from  the  consignee,  the  consignor  en- 
ters on  his  journal  or  cash  record  the  amount  of  the  proceeds  of 
the  shipment,  the  account  sales  constituting  the  only  record 
kept  by  the  consignor  of  the  consignee's  commission  and  ex- 
penses. A  controlling  account  may  thus  be  opened  with  ship- 
ment profit  and  loss.  If  shipment  proceeds  are  always  received 
in  cash  as  each  account  sales  is  made,  a  column  on  the  debit 
side  of  the  cash  journal  headed  Shipment  Profit  and  Loss  — 
Shipment  Proceeds  will  fully  provide  for  the  entry  of  the  data 
received  from  the  consignee.  In  the  case  of  the  shipment  used 
for  illustration,  the  receipt  of  Woodrow's  check  is  recorded  on 
King's  books  by  the  following  journal  entry; 

January  15,  192 1 

Cash  195  50 

Sh.  P.  and  L. —  Shipment  Proceeds  195 .  50 

(Shipment  No.  i) 

Proceeds  of  sale  of  50  bbls.  apples  con- 
signed to  H.  P.  Woodrow,  Center,  111. 

The  entry  in  this  instance  would  be  made  on  the  debit  side  of 
the  cash  journal,  in  the  column  headed  Shipment  Profit  and 
Loss  —  Shipment  Proceeds,  opposite  the  subsidiary  account  of 
Shipment  No.  i,  and  extended  into  the  Bank  Deposit  column, 
following  the  illustration  given  below. 

Frequently,  periodic  settlements  are  made  by  the  consignee 
covering  a  number  of  shipments,  the  shipment  proceeds  being 
during  the  interim  credited  to  the  consignor  by  the  consignee. 
Cases  of  this  kind  can  be  readily  provided  for  by  placing  a  Ship- 


CONSIGNMENTS  253 

ment  Profit  and  Loss — Shipment  Proceeds  column  in  the  gen- 
eral journal,  as  shown  below.  For  example,  had  the  account 
sales  covering  our  apple  shipment  not  been  accompanied  by 
cash,  the  shipment  proceeds  would  have  been  entered  by  King 
in  his  general  journal  in  the  following  manner: 

Accounts  Receivable  i95  •  50 

(H.  P.  Woodrow) 

Sh.  P.  and  L. —  Shipment  Proceeds  195 .  50 

(Shipment  No.  i) 

Proceeds  of  Shipment  No.  i  due  from 

Woodrow,  consignee. 

The  exact  form  in  which  the  entry  is  made  is  indicated  in 
the  illustration  given  below. 

If  shipment  No.  2  to  H.  P.  Woodrow  by  King  be  100  barrels 
of  apples  costing  $3.50  per  barrel  to  be  sold  at  S5.00  per  barrel 
on  a  10%  commission,  the  entries  on  King's  books  would  be  as 
follows: 

Sh.  P.  and  L. —  Cost  of  Goods  Shipped    350 .  00 

(Shipment  No.  2) 

Purchases  350.00 

If  there  were  charges  paid  on  the  shipment  for  freight-out 
amounting  to  $4.50  the  entry  would  be: 

Sh.  P.  and  L. —  Charges  (freight)  4. 50 

(Shipment  No.  2) 

Cash  4 .  so 

Let  us  suppose  further  that  Woodrow  sends  his  account  sales 

as  follows: 

January  20,  192 1 

100  bbls.  of  apples  at  $5.00  per  bbl.  $500.00 

Dray  age  2.75 

Commission  50.00  52.75 

Balance  due  (cash  inclosed)  $447 .  25 

King  would  make  the  following  entry: 

January  20,  192 1 
Cash  447-25 

Sh.  P.  and  L.—  Sh.  Proceeds  447-25 

(Shipment  No.  2) 


254 


ACCOUNTING  PRINCIPLES 


6.  Closing  of  the  Consignment  Books.  —  In  the  closing  of 
the  consignment  books,  the  subsidiary  accounts  are  provided 
for  through  the  posting  of  the  detailed  entries  in  the  various 
journals.  The  controlling  accounts,  however,  are  debited  and 
credited  by  means  of  closing  entries  of  a  character  similar  to 
those  of  the  following  illustration.  A  final  general  journal  entry 
closes  the  shipment  profit  and  loss  into  the  regular  profit  and 
loss  for  the  period  under  view. 

The  controlling  account  for  the  two  shipments  would  be  as 
follows: 

SmPMENr  Profit  and  Loss 


Cost  of  Goods  Shipped 
Shipment  Charges 

Net  Profits 

500 . OD 
29.50 
529-50 

113-25 

642.75 

Shipment  Proceeds 


642.7s 


642.75 


The  two  subsidiary  accounts  would  appear  in  the  subsidiary 
shipment  ledger  as  follows: 

Shipment  No.  i  —  H.  P.  Woodrow,  Center,  III. 


Jan. 


IS    Net  Profit 


150.00 
25.00 
175 .  00 
20.50 


195-50 


Jan.  15 


195  50 


195  50 


Shipment  No.  2  —  H.  P.  Woodrow,  Center,  111. 


Jan.    5 
5 

20    Net  profit 

350-00 
4-50 
354  50 

92.75 

Jan.  20 

447   25 

447-25 

447-25 

The  shipment  profit  and  loss  controlling  account  serves  the 
purpose  of  showing  to  King,  the  consignor,  what  the  total  prof- 
its on  his  shipment  business  are  and  the  detail  shipment  ac- 


CONSIGNMENTS  255 

counts  serve  the  purpose  of  showing  to  King  the  amount  of  the 
net  profits  on  each  consignment.  It  will  be  noted  that  the  sum 
of  the  net  profit  balances  shown  by  the  subsidiary  accounts 
equals  the  net  profit  balance  shown  by  the  controlling  account. 
There  is  an  inventory  to  be  entered  in  those  cases  where  the 
account  sale  is  rendered  before  all  the  goods  shipped  have  been 
sold.  The  ledger  accounts  of  Illustration  No.  26  show  how  the 
inventory  is  entered. 

7.  Inventory  of  Goods  Shipped.  —  At  the  periodic  closings, 
along  with  the  regular  merchandise  inventory,  account  must  be 
taken  of  the  consignment  goods  still  unsold  by  the  consignees. 
As  it  is  not  always  convenient  to  wait  for  a  statement  from 
them  of  the  goods  on  hand,  the  consignment  goods  inventory 
is  usually  calculated  by  means  of  the  accounts  sales.  To  make 
this  calculation  possible,  there  is  entered  in  red,  in  both  the 
cash  journal  and  the  general  journal  in  the  column  to  the  right 
of  the  column  for  shipment  proceeds,  along  with  the  entry  of 
the  account  sales  data,  the  cost  of  the  goods  sold,  the  red-ink 
entries  simply  indicating  that  these  figures  are  not  to  be  added 
with  the  black-ink  entries  to  be  found  in  the  same  column.  The 
total  of  these  red-ink  entries  represents  the  cost  of  the  goods 
sold  during  the  period  under  consideration,  and,  when  sub- 
tracted from  the  cost  of  the  total  goods  shipped,  discloses  the 
cost  of  the  goods  still  on  hand,  or  the  inventory  of  consignment 
goods.  This  inventory  is  then  credited  to  the  shipment 
profit  and  loss  before  the  latter  account  is  closed  into  the 
general  profit  and  loss,  and  debited  to  a  new  account  of  in- 
ventory of  goods  shipped  or  simply  brought  down  as  the  debit 
balance  of  the  cost  of  goods  shipped  account  for  the  succeeding 
period,  the  necessary  memorandum  entry  being  made  to  show 
the  nature  of  the  beginning  charge.  It  would  also  be  advan- 
tageous to  carry  in  the  memorandum  columns  of  the  shipment 
ledger  the  cost  figures  of  goods  sold  when  the  credit  for  ship- 
ment sales  is  made  from  the  account  sales  to  the  subsidiary 
shipment  account.  The  account  would  then  show  data  for 
calculating  the  merchandise  inventory  credit  to  be  used  in 
the  subsidiary  account. 


256  ACCOUNTING  PRINCIPLES 

8.  Illustration.  —  The  illustration  given  below  gives  in  defi- 
nite form  the  treatment  of  consignment  transactions  in  accord- 
ance with  the  principles  discussed  above. 

CONSIGNMENT  TRANSACTION  FOR 
ILLUSTRATION  NO.  26 

I.  Organization  of  the  Valley  Book  Store.  —  The  Valley  Book 
Store  is  organized  to  do  a  wholesale  business  in  books.  It  plans  to 
sell  books  on  consignment  and  also  to  sell  goods  consigned  to  it. 

It  organizes  with  a  capital  of  $50,000.00  and  takes  over  the  business 
of  K.  C.  Johns  on  the  following  statement  of  assets  and  h'abilities: 


Balance  Sheet  of  K.  C.  Johns 

June  30,  1919 
Assets                                              Liabilities 

Cash                                1,000.00      .^ccoimts  Payable 
Books                            10,000 .  00      Capital 
Stationery                       5,000 .  00 
Furniture  and  Fixtures   2 ,000 .  00 

5,000.00 
13,000.00 

18,000.00 

18,000.00 

The  Valley  Book  Store  allows  $3,000.00  to  K.  C.  Johns  for  good- 
will, and  takes  over  his  business,  assuming  his  liabilities.  Randolph 
Jones  contributes  $30,000.00  of  the  capital  and  K.  C.Johns,  $20,000.00. 
Profits  and  losses  are  to  be  shared  according  to  capital. 

II.  Keeping  the  Laboratory  Books. —  No  detail  customer  and 
creditor  accounts  will  be  kept  except  in  connection  with  consignment 
transactions.    The  consignment  business  will  be  confined  to  books. 

III.  Transactions  for  July,  191 Q. — 

July  I  (M.).     The  business  buys  on  credit  goods  as  follows: 

Books  $5,000.00  Stationery  .  $2,000.00 

July  2  (T.).  It  receives  $3,125.00  of  books  on  consignment  from 
McClure  s  New  Book  Store,  Chicago,  111.,  as  follows: 

300  Jones'  Laws  of  Contracts  to  be  sold  at  $5.00   $2,500.00 
250  Hortcut's  Business  Law  to  be  sold  at  $2.50  625 .00 

$3,125.00 

The  books  are  to  be  sold  on  a  commission  of  10  per  cent  and  settle- 
ment is  to  be  made  at  the  end  of  each  week.  The  freight  and  cartage- 
in  were  $50.00;  telephone  and  telegraph,  $1.50, 


CONSIGNMENTS  257 

July  3  (W.) .  The  Company  ships  3  50  copies  of  WiUis  on  Sales  which 
cost  $5.cx)  per  copy  to  the  Wisconsin  Corporation  Book  Store,  Cedar 
Grove,  Wis.,  to  be  sold  at  $7.50  per  copy,  commission  10  per  cent. 

July  4  (T.).  The  Company  pays  $2.00  for  cartage  and  receives  a 
bill  from  the  Valley  Central  Railroad  for  freight  on  this  shipment, 
$30.00. 

July  6  (F.).     The  Company  pays  its  weekly  payroll  as  follows: 

R.  C.  Criswell,  Manager  $  50.00 

T.  J.  Caft,  Salesman  30.00 

R.  M.  Paine,  Bookkeeper  35  00 

G.  M.  Ross,  Shipping  Clerk  25.00 

K.  R.  Kenedy,  Stenographer  20.00 

R.  B.  Klette,  Traveling  Salesman  35  00 

B.  C.  Kohler,  Traveling  Salesman  35  00 

L.  R.  Trailer,  Traveling  Salesman  30 .  00 

S260.00 
The  credit  sales  for  the  week  were: 

Books  $2,000.00 

Stationery  1,500.00 

The  Company  received  the  following  account  sales  from  the  Wis- 
consin Book  Store,  Cedar  Grove,  Wis.: 

Sales  $375.00 

Cartage  3 .  00 

Damage  Discounts  10.00 

Commission  3  7  •  50           5° .  50 

Balance  Due  Consignor  $324. 50 
(Check  inclosed) 

It  sends  to  the  McClure's  Book  Co.,  Chicago,  111.,  the  following 
account  sales: 

75  Jones'  Laws  of  Contracts,  at  5.00 
50  Hort cut's  Business  Law,  at  2.50 

Total  Sales 
Freight  and  Cartage-In 
Telephone  and  Telegraph 
Commission 

Balance  Due  Consignor  $411.00 

(Check  inclosed) 

Jiily  6.     Cash  Sales  for  week: 

Book  Sales  $  500 .  00 

Stationery  Sales  225.00 

Paid  on  accounts  payable  .',500.00 


$37500 

125.00 

500.00 

50 

.00 

I 

.50 

37 

l55 

89.00 

258  ACCOUNTINC;  PRINCIPLES 

July  8.  The  Company  takes  out  a  $16,000.00  fire  insurance 
three-year  policy  and  pays  a  premium  of  $60.00  to  the  Renox  Fire 
Insurance  Co 

July  9.  It  purchases  on  time  additional  stock  as  follows:  books, 
$2,000.00;  stationery,  $1,000.00.  The  Company  decides  to  buy  the 
building  in  which  it  does  business  from  the  \'allcy  Trust  Co.  at 
$10,000.00.  It  plans  a  6%  ten-year  mortgage  on  the  building  with 
the  Trust  Co.  for  S8,ooo.co;  pays  $1,000.00  in  cash  and  makes  a  two- 
year  8 /c  i^ote  to  the  \'al!ey  Trust  Co.  for  the  balance. 

July  10.  The  Company  ships  to  the  Macon  Book  Co.,  Macon, 
Minn.,  300  copies  of  Johnson  on  Agency,  which  cost  $4.00  per  copy,  to 
be  sold  at  $6.50  per  copy.  The  goods  are  shipped  over  the  National 
Railway,  which  sends  a  bill  for  $35.00  freight.  The  cartage  was  $2.50, 
which  was  paid  in  cash  to  the  Valley  Express  Co.     Commission  10%. 

July  II.    The  Company  lost  in  a  fire  stock  as  follows: 

Books  $5,000.00 

Stationery  3,000.00 

The  Insurance  Company  in  this  case  according  to  the  policy  re- 
quired the  insured  to  bear  25  per  cent  of  the  loss.  The  Insurance 
Company  paid  in  cash  the  amount  due  and  the  book  company  marked 
down  accordingly  the  book  value  of  its  insurance. 

July  12.  Instead  of  charging  the  fire  loss  to  profit  and  loss  the 
stockholders  decided  to  reduce  the  capital  by  the  amount  of  the  loss 
falling  on  the  company,  each  stockholder  bearing  the  loss  in  proportion 
to  his  capital. 

July  13.  The  Company  received  from  the  Wisconsin  Corporation 
Book  Store  the  following  account  sales: 

100  Williston  on  Sales,  at  $7.50  $750.00 

Commission  on  Sales  75  00 

Due  Consignor  (check  «o/ inclosed)  $675.00 

(If  this  report  were  frequently  without  a  check  enclosure,  how 
would  the  journal  be  ruled?) 

The  payroll  was  disbursed  as  in  the  preceding  week. 

The  Company  sends  the  Mi  Clxire's  Book  Co.  the  following  account 
sales: 

125  Jones'  Law  of  Contracts,  at  5.00  $625.00 

100  Hortcut's  Business  Law,  at  2.50  250.00 

Total  875.00 

Commission  87.50 

Due  Consignor  (check  inclosed)  $787 .  50 


CONSIGNMENTS  259 

Credit  sales  for  the  week: 

Books  $1,800.00 

Stationery  900 .  00 
Credit  purchases: 

Books  5,000.00 

Stationery  2,750.00 
Cash  sales: 

Books  750.00 

Stationery                          *  500.00 

Received  on  account             '  3,500.00 

Paid  on  accounts  10,000 .  00 

Discount  on  sales  50 .  00 

Discount  on  purchases  125.00 

July  20.  (Week  of  July  1 5-20.)  (For  the  remainder  of  the  month 
the  sales  and  purchases  will  be  given  as  a  total  and  the  details  of  the 
consignment  sales  and  the  shipments  will  be  given  for  the  week  as  a 
whole.) 

At  the  end  of  the  week  the  Company  received  from  the  Wisconsin 
Corporation  Book  Store  the  following  account  sales: 

100  Williston  on  Sales,  at  $7.50  $750.00 

Refund  on  Defective  Copy  5 .  00 

Commission  75- 00          So.oo 

Due  Consignor  (check  inclosed)  $670.00 

It  sent  the  following  accoimt  sales  to  the  McClure's  Book  Co. : 

150  Jones'  Laws  of  Contracts,  at  $5.00  $750.00 

50  Hortcut's  Business  Law,  at  $2.50  125.00 

Total  $875.00 

Commission  on  Sales  87 .  50 

Due  Consignor  (check  inclosed)  $787 .  50 

The  regular  payroll  was  disbursed. 

Piu-chases  on  credit  for  the  week: 

Books  $3,000.00 

Stationery  i ,  7  50 .  00 

Credit  Sales:  $4,7 50. 00 

Books  $3,500.00 

Stationery  2 ,000 .  00 

$5,500.00 
Paid  on  accoimt  4, 500 .  00 

(Includes  disc,  of  $75.00) 
Received  on  accoimt  5,000.00 

(Includes  disc,  of  $87.50) 


26o 


ACCOUNTING  PRINCIPLES 


Cash  sales: 

Books 
Stationery 


$8,000.00 
550  00 


July  27.     (Week  ending  Jvdy  27.)    The  Comp>any  sent  to  the 
McClure's  Book  Co.  its  weekly  account  sales  as  follows: 


100  Jones'  Laws  of  Contracts,  at  $5.00 
50  Hortcut's  Business  Law,  at  $2.50 

Total 
Commission 

Due  Consignor  (check  inclosed) 


$500.00 

12500 

625.00 

62.50 

$562.50 


There  remained  of  this  consignment  only  50  Jones'  Law  of  Con- 
tracts. 
The  Macon  Book  Co.  sends  the  following  account  sales: 


250  Johnson  on  Agency,  at  $6.50. 
Telephone  and  telegraph 
Cartage 
Commission 
Due  Consignor  (check  inclosed) 

Its  purchases  for  the  week  were: 

Books 
Stationery 

Its  credit  sales  were: 

Books 
Stationery 

Cash  Sales: 

Books 
Stationery 

Received  on  account 
Less  discounts 

Paid  on  account 
Less  discoimts 


$1,625.00 


2.50 

3-25 
162.50 


174-75 
$1,450.25 


$4,000.00 

1,800.00 

$5,800.00 


$5,000.00 

2,250.00 

$7,250.00 


$780.00 

480.00 

$1,260.00 

8,000.00 

1,200.00 

$6,800.00 

1. 100. 00 

150.00 

$950.00 


CONSIGNMENTS  261 

It  was  decided  to  make  the  payroll  monthly  for  the  future  and  pay 
it  on  Saturday  of  the  first  week  of  the  month.  The  store  was  closed 
for  inventory  on  July  31.  i  .         I  ;    1 

Regular  payroll  was  disbursed.  1  •  ij 


262 


ACCOUNTING  PRINCIPLES 


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Cash  in  bank  . 
Increased  Capital 
Inv,  in  business   . 
Wis.  Book  Store  . 
Cash  Sales 
McClure's       .     . 
Settlement  Ins.  Co. 
Cash  Sales 
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McClure's       .     . 
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1 

K.  C.  Johns,  Capital  . 
R.  Jones,  Capitid  . 
Shipment  Mi. 

Consignment  Mi.     . 
Fire  Loss     .... 

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Consignment  Mi.     . 

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3  W    3 

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CONSIGNMENTS 


275 


u 

H 
(/] 

M 
O 

C/2 


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8  8  8  8  8  8  8  8 

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276 


ACCOUNTING  PRINCIPLES 


<u 


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.005 


10  !l 


00   00  00    t^ 

M      C«      C«      <N 


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o 

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8 


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93 

1 


2  •-  *  a 


C/5 


J3  ^  X  ^ 


CONSIGNMENTS 


277 


GENERAL  LEDGER 

Valley  National  Bank 


I9I9 

1919 

July 

31 

C271 

66,067 

25 

July 

31 
31 

66,067 

25 

Aug. 

1 

Balance 

42,612 

75 

Balance 


C273 


23.454 
42,612 


66,067 


Accounts  Receivable 


I9I9 

1919 

July 

31 

G265 

675 

00 

July 

31 

31 

3,125.00 

^275 

18,950 
10,625 

00 
00 

C27I 


16,500 


Deferred  Expense 


I9I9 

1919 

July 

31 

Insurance 
Shipment 

G265 

2g 

17 

Charges 

G265 

15 
44 

39 
56 

Books  Inventory 


I9I9 
July 

2 

G262 
G267 

10,000 

00 
00 

1919 
July 

II 

31 

Trading 

G264 
G267 

S,ooo 
5,000 

00 
00 

10,000 

10,000 

00 

Aug. 

I 

11,972 

00 

278 


ACCOUNTING  PRINCIPLES 
Stationery  Inventory 


I9I9 
July 

I 

G262 
G267 

S.ooo 

00 

1919 
July 

II 
31 

Trading 

G264 
G267 

3.000 
2,000 

00 
00 

5,000 

00 

5.000 

00 

July 

31 

6,257 

00 

Merchandise  Inventory  —  Shipments 


I9I9 

July 

31 

G265 

700 

00 

Furniture  and  Fixtures 


1919 
July      I 


G262 


2,000 


Reserve  for  Depreciation  —  Furniture  and  Fixtures 


I9I9 
July 

31 

G266 


15 


Buildings 


I9I9 

July 

9 

C272 

1,000 

00 

9 

G263 

9,000 

00 

Reserve  for  Depreciation  —  Buildings 


I9I9 
July 

31 

G266 


40 


CONSIGNMENTS 
Goodwill 


279 


1919 

July 

I 

G262 

3,000 

00 

Notes  Payable 


I9I9 

July 

9 

G263 


1,000 


Accounts  Payable 


1919 
July 


31 


I9I9 

C279 

19,100 

00 

July 

31 
31 

G265 
Shp.i 

5,000 
65 

00 

00 

31 

14,263 

P274 

28,300 

00 

Accrued  Expense 


I9I9 
July 

31 
31 

Ace.  Int.  on 
Mtg.  Pay. 

Ace.  Int.  on 
Notes  Pay. 


G266 
G266 


Mortgage  Payable 


I9I9 
July 

9 

G263 


8,000 


Randolph  Jones,  Capital 


I9I9 

1919 

July 

12 

G264 

1,200 

00 

July 

I 

31 

Balance 

33,815 

18 

31 

33.921 

44 

Aug. 

I 

Orig.  Inv. 
Net  Gain  - 
July 

Balance 


C270 
G269 


30,000 

5.015 
33.921 
33.815 


18 

44 
18 


28o 


ACCOUNTING  PRINCIPLES 
K.  C.  Johns,  Capital 


I9I9 

July 

12 
31 

Balance 

G264 

800 
22,543 

00 
46 

1919 
July 

I 

I 

31 

23.343 

46 

Aug. 

I 

Books  Sales 


Orig.  Inv. 
Orig.  Inv. 
Net  Gain  - 
July 

Balance 


G262 
C270 

G269 


16,000 
4,000 

3.343 


23.343 


22,543 


46 


46 


1919 
July 


31 


Trading 


G267 


15.130 


1919 
July 


31 


S275 


15.130 


Stationery  Sales 


1919 
July 


31 

Trading 

G267 

8,405 

00 

1919 
July 

31 

S27S 


8,405 


Consignment  N 

0.    I  — 

McClltie's 

New  Book  Store 

I9I9 

1919 

July 

6 

G263 

37 

50 

July 

6 

C270 

500 

00 

2 

C2 

51 

50 

13 

C270 

875 

00 

6 

C2 

411 

00 

20 

C270 

875 

00 

13 

G264 

87 

50 

27 

Ci 

625 

00 

20 

C2 

787 

50 

20 

G265 

87 

50 

27 

C2 

562 

50 

27 

G265 

62 

50 

2.875 

00 

2.875 

00 

Commissions  Earned 


1909 

1919 

July 

31 

Gen.P.&L. 

G269 

275 

00 

July 

6 

13 
20 
27 

Gi 

G264 
G265 
G265 

37 
87 
87 
62 

SO 
SO 
SO 
00 

275 

00 

275 

00 

CONSIGNMENTS 
Books  Purchases 


281 


1919 
July 


31 


P274 


19,000 


19,000  00 


1919 
July 


Sh.P.&L. 
Trading 


SJ276 
G267 


2,95° 
16,050 


19,00000 


Discount  on  Purchases 


1919 
July 


31 


Gen.P.&L, 


G269 

350 

00 

I9I9 
July 

31 

C273 


350 


Stationery  Purchases 


1919 
July 


31 


P274 


9.300 


1919 
July 


31 


Trading 


G267 


9.300 


Fire  Loss 


I9I9 
July 

II 

C264 

8,000 

00 

1919 
July 

II 
12 

C270 
G264 

6,000 
2,000 

00 
00 

8,000 

00 

8,000 

00 

Salaries 


I9I9 

1919 

July 

6 

C272 

260 

00 

July 

31 

Gen.P.&Li 

G268 

780 

00 

13 

C272 

260 

00 

31 

Gen.P.&L. 

G269 

260 

00 

20 

C272 

260 

00 

27 

C272 

260 

00 

1,040 

00 

1,040 

00 

282 


ACCOUNTING  PRINCIPLES 
Insurance 


I9I9 
July 

8 

C2 

60 

00 

1919 
July 

II 
31 
31 

60 

00 

Gen.  P  &  L. 
Gen.  P.  &  L. 


G264 
G266 


60 


Discount  on  Sales 


1919 
July 


31 


C271 


1.337 


SO 


1919 
July 


31 


Gen.  P.&L. 


Gs 


1.337 


SO 


Depreciation 


1919 

July 


1919 

31 

Buildings 

G266 

40 

00 

July 

31 

31 

Fur.  &  Fix. 

G266 

15 

00 

20 

= 

55 

00 

Gen.  P.  &  L. 


G5 

55 

55 

Trading 


I9I9 

1919 

July 

31 

Books  Inv. 

July 

31 

Books  Inv., 

I  St  per. 

G5 

5.000 

00 

End  period 

G267 

11,972 

00 

31 

Stat.  Inv. 

31 

Stat.Inv.end 

I  St  p>er. 

G5 

2,000 

00 

pr. 

G267 

6,257 

00 

31 

Books  Pur. 

G5 

16,050 

00 

31 

Books  Sales 

G267 

15.130 

00 

31 

Stat.  Pur. 

Gs    9,300 

00 

31 

Stat.  Sales 

G267 

8,405 

00 

31 

Gross  P. 

G268 

9.414 

00 

41,764 

00 

41,764 

00 

I 

CONSIGNMENTS 
Shipment  Profit  and  Loss 


283 


Tulv 

31 

Cost  of  goods 

July 

31 

Pro.  of  Ship- 

shipped 

SJ 

2,950 

00 

ments 

C271 

2,444 

75 

Charges 

C273 

4 

50 

Pro.  of  Shp. 

G265 

67s 

00 

Charges 

SJ 

65 

CX) 

Charges  (de- 

Net profits 

G266 

815 

64 

ferred) 
Ship.  Inv. 

G265 
G26S 

IS 
500 

39 
00 

<^ 

= 

Ship.  Inv. 

G26S 

200 

00 

3.835 

14 

3.835 

14 

General  Profit  and  Loss 


I9I9 

1919 

July 

II 

Insurance 

G264 

30 

00 

July 

31 

P.&L.Shipts. 

G266 

815 

64 

31 

Insurance 

G268 

83 

31 

Trading 

G268 

9.414 

00 

31 

Salaries 

G268 

780 

00 

31 

Commissions 

G269 

275 

00 

31 

Disc,  on 
Sales 

G268 

1.337 

50 

31 

Disc,  on  Pur. 

G269 

350 

00 

31 

Interest 

G2e6 

32 

67  ■ 

31 

Depreciat. 

G268 

55 

00 

31 

Salaries 

G269 

260 

00 

31 

K.C.  Johns, 
Cap. 

G6 

3.343 

46 

31 

R.  Jones, 

Capital 

G6 

5.015 

18 

64 

10,854 

10,854 

64 

SHIPMENT  LEDGER 
Shipment  No.  i  —  Wisconsin  Corporation  Book  Store 


I9I9 

1919 

July 

3 

SJ276 

1.750 

00 

July 

6 

C270 

324 

SO 

4 

C272 

2 

00 

13 

G264 

675 

00 

3 

SJ276 

30 

00 

20 

C270 

670 

00 

31 

G266 

396 

64 

31 

Inventory 

G26S 

500 

00 

31 

G265 

9 

14 

2,178 

64 

2.178 

64 

284 


ACCOUNTING  PRINCIPLES 
Shipment  No.  2  —  Macon  Book  Co. 


1919 

1919 

July 

10 

SJ276 

1,200 

00 

July 

27 

C270 

I.4SO 

25 

10 

C272 

2 

50 

31 

G284 

200 

00 

10 

SJ276 

35 

00 

31 

G265 

6 

25 

31 

G266 

419 

00 

1,656 

50 

1,656 

50 

CHAPTER  XX 

TRANSACTIONS  FOR  MARCH 

In  the  month  of  March  the  business  of  Williams  and  Day  is 
continued  on  the  same  salary  basis  as  in  the  preceding  month. 

March  i.     The  following  accounts  are  paid  in  full: 

Haywood  Furniture  Co.  $2,746.25 

Tobey  Furniture  Co.  2,002.50  disc.  $7.05 

March  2.  A  check  for  $42.35  is  received  from  Peter  Wilson  for 
a  C.  O.  D.  sale  made  on  February  28th. 

The  Company  also  receives  on  consignment  100  automatic 
window  fasteners  from  Beecher  Sash  &  Door  Co.  to  be  sold  at  $5.00 
per  set  on  a  commission  of  10%.  A  settlement  is  to  be  made  each 
week  on  fasteners  sold.  The  Company  paid  cartage  of  50  cents  on 
these  fasteners  to  the  Transfer  Co. 

March  3.     The  following  bills  are  paid  in  cash: 

City  Garage         $64.00  for  two  new  tires  to  replace  truck  tires 

discarded 
City  Garage  5.00  for  100  gallons  gasohne 

Jno.  Cox  3.00  for  shoeing  horses 

Jay  Leather  Co.      25.00  for  additional  set  of  harness. 

Receives  on  consignment  200  Adjustable  shades  from  Mueller 
Shade  Co.  to  be  sold  at  $3.00  each,  commission  10%.  Pays  $1.25 
express  and  cartage.  Account  is  to  be  rendered  each  week  provided 
a  dozen  or  more  shades  are  sold  during  the  week. 

A  C.  O.  D.  sale  of  furniture  is  made  to  the  Smith  Institute  for 
$250.00. 

The  weekly  payroll  is  paid. 

March  2.  A  check  for  $42.35  is  received  from  Peter  Wilson  for 
a  C.  O.  D.  sale  made  on  February  28th. 

The  Company  also  receives  on  consignment  100  automatic  window 
fasteners  from  Beecher  Sash  &  Door  Co.  to  be  sold  at  $5.00  per  set 
on  a  commission  of  10%.  A  settlement  is  to  be  made  each  week  on 
fasteners  sold.  The  company  paid  cartage  of  50  cents  on  these 
fasteners  to  the  Transfer  Co. 

28s 


286  ACCOUNTING  PRINCIPLES 

March  3.    The  following  bills  are  paid  in  cash: 

City  Garage         $64.00  for  two  new  tires  to  replace  truck  tires 

discarded 
City  Garage  5.00  for  100  gallons  gasoline 

Jno.  Cox  3.00  for  shoeing  horses 

Jay  Leather  Co.     25.00  for  additional  set  of  harness. 

Receives  on  consignment  200  Adjustable  shades  from  Mueller 
Shade  Co.  to  be  sold  at  $3.00  each,  commission  10%.  Pays  $1.25 
express  and  cartage.  Account  is  to  be  rendered  each  week  provided 
a  dozen  or  more  shades  are  sold  during  the  week. 

A  C.  O.  D.  sale  of  furniture  is  made  to  the  Smith  Institute  for 
$250.00. 

March  5.  The  Smith  Institute  refuses  to  receive  $50.00  worth  of 
the  furniture  sold  on  the  4th  on  the  ground  that  the  pieces  are  de- 
fective, and  gives  a  check  for  $200.00  covering  the  balance  of  the 
purchase. 

Collections  on  accoimt  have  been  as  follows: 


Name 

Amount 

Discount 

St.  Ltike  Hospital 

$300.00 

Smith  Institute 

156.00 

J.  H.  Brigham 

85-75 

K.  C.  Riley 

144.00 

$2.88 

H.  P.  Square  Business  College 

125.00 

Foster  HaU 

80.00 

Randoph  Furniture  Co. 

265.00 

5  30 

George  Carey 

76.00 

A.  W.  Martin 

215.00 

J.  Collins 

47500 

Fulton  Furniture  Co. 

450.00 

Newsome  Fumitiu-e  Co. 

386.50 

387 

$2,758.45 

March  6.  George  Carey's  check  for  $76.00  is  dishonored  by  the 
bank  because  of  no  funds.  (Remember  that  accoimts  receivable 
must  be  charged  with  this  amount  as  well  as  George  Carey's  personal 
account.) 

March  7.  Consignment  cash  sales  for  the  past  week  were  as  follows: 

50  automatic  fasteners  $250.00 

30  adjustable  shades  90 .  00 

Render  account  sales  and  make  all  necessary  entries.  Inclose  in 
cash  the  amounts  due  consignors. 


TRANSACTIONS  FOR  MARCH  287 

March  8.  The  following  invoice  is  received  from  the  Tobey  Fur- 
niture Co.: 

Terms  2/10,  n/30. 

Carpets  $1,150.00 

Furniture  2 ,  500 .  00 

$3,650.00 

The  firm  ships  to  be  sold  on  consignment  the  following  goods: 

(a)  To  the  Swanson  Furniture  Co.,  Carson,  Mo.,  10  Oriental  rugs 
costing  $6,000.00,  to  be  sold  40%  over  cost.  Ten  per  cent  of  the  sale 
price  is  to  be  paid  as  commission.  Freight  bill  covering  shipment 
($4)  was  received  from  Valley  Railroad  and  paid.  An  account  sales 
is  to  be  rendered  at  the  end  of  each  week  covering  sales  made. 

(b)  To  Smithson  Hardware  Co.,  Smithville,  111.,  50  O.  K.  churns 
costing  $4.00  each  to  be  sold  at  $6.00  with  a  commission  of  75  cents 
for  each  chum  sold.  Freight  of  $3.00  was  paid  to  the  Valley  Railroad 
Co.  and  the  drayage  of  50  cents  paid  to  the  Valley  Transfer  Co. 

(c)  To  Mason  Furniture  Co.,  Mason,  Kansas,  50  Universal  Filing 
Cabinets  costing  $30.00  each  to  be  sold  at  $50.00  with  commission  of 
$5.00  on  each  sale.  Valley  Storage  Co.  crated  and  delivered  to  the 
depot  the  cabinets  making  a  charge  of  50  cents  each.  The  freight 
charge  by  the  Valley  Railroad  was  $15.00. 

March  9.  On  arrival  of  the  goods  listed  in  the  Tobey  invoice  of 
March  8th,  goods  worth  $150.00  are  returned  as  unsuitable.  Of  the 
amount  $100.00  was  for  furniture  and  $50.00  for  carpets. 

Regular  payroll  is  disbursed. 

Furniture  was  purchased  from  the  Haywood  Furniture  Co.  on 
account,  $50.00. 

March  12.  Payments  are  made  from  cash  as  follows:  Coal,  $6.00; 
ofl&ce  supplies,  $7.50.     Both  items  are  charged  to  general  expense. 

Make  out  accoimt  sales  covering  the  following  consignment  sales: 

50  automatic  window  fasteners  (sold  on  credit  to  K.  C.  Riley) 
60  adjustable  shades  (sold  on  credit  to  St.  Luke  Hospital) 

Credit  consignor  for  proceeds  instead  of  inclosing  check. 
Received  for  record  the  following  account  sales: 
(a)   From  Swanson  Furniture  Co.,  Carson,  Mo.: 

Sales  of  Oriental  rugs 

Cartage 

Telegram 

Commission  (10%) 

Proceeds  (check  inclosed)  $2,518.75 


288  ACCOUNTING  PRINCIPLES 

(b)  From  Smithson  Hardware  Co.,  Smithville,  Dl.: 

25  O.  K.  Chums,  at  $6.00  $150.00 

Repairs  on  imjjerfect  chums  2 .  50 

Cartage  .  50 

Commission  (75  cents)  18.75  21.75 

Proceeds  (charge)  $128.25 

(c)  From  the  Mason  Fumiture  Co.,  Mason,  Kansas: 

20  Universal  Filing  Cabinets,  at  $50.00  $1,000.00 

Cartage  2 .  00 

Commission  ($5.00)  100.00        10200 

Proceeds  (check  inclosed)  $898 .  00 

March  14.  The  Tobey  invoice  of  March  8  is  paid,  the  discount 
being  $70.00.     (Remember  the  $150.00  returns.) 

March  15.  The  firm  decides  to  borrow  on  demand  from  Frank 
WiUiams  $5,000.00  at  69c,  giving  a  note  of  the  firm  for  this  amoxmt. 
(Since  a  loan  from  a  partner  is  on  a  different  basis  from  liabilities  to 
persons  outside  the  business,  an  account,  loans  from  partners,  should 
be  ojjened  to  which  such  items  should  be  credited.)  The  note  of  the 
Fulton  Fumiture  Co.  for  $500.00  at  7%  dated  January  i  and  due 
September  i  is  discoimted  at  the  bank  at  8%.  (At  the  time  of 
maturity  this  note  will  be  worth  its  face,  $500.00,  plus  interest  at  7% 
for  20  months,  $58.33,  or  $558.33.  The  bank  discoimts  this  amoxmt, 
$558.33,  for  the  time  the  note  has  still  to  nm,  17^^  months,  at  8%. 
The  discount  is  $65.14,  leaving  the  net  proceeds  of  the  note  $493.19. 
The  entry  could  be  made  debiting  cash  $493.19  and  interest  $6.81, 
and  crediting  notes  receivable  discoimted  $500.00.  Since,  however, 
it  is  desirable  to  show  in  the  statement  of  profit  the  earnings  from 
interest  and  also  the  cost  of  interest,  it  is  better  to  make  the  entry 
in  this  form:  debit  cash  $493.19  and  interest  $65.14.  and  credit 
notes  receivable  discounted  $500.00  and  interest  $58.33.  This 
entry  can  be  made  in  the  cash  book  in  this  form  by  writing  the 
debit  to  interest  in  red  ink  in  the  General  column  and  posting  the 
item  to  the  debit  of  interest  at  the  end  of  the  month.) 

March  16.  Stock  is  increased  by  the  following  purchase  from  the 
Wilson  Carpet  Co.,  terms  2/10,  n/30: 

Fumiture  $4,000.00 

Carpets  2.000.00  $6,000.00 

March  17.  Day  is  allowed  to  withdraw  $500.00  indefinitely. 
The  regular  payroll  for  the  week  is  disbursed. 

March  19.  The  Rapid  Repair  Co.  reports  work  done  for  cash  as 
follows: 


TRANSACTIONS  FOR  MARCH  289 

H.  P.  Square  Business  College  $50 .  00 

J.  Collins  75  00 

H.  R.  Scott  25.00 

The  customers  are  charged  for  the  work. 

March  19.  Purchased  furniture  from  the  Tobey  Furniture  Co.  on 
account  for  $50.00,  and  from  the  Lacy  Lock  &  Safe  Co.  on  account 
for  $35.00. 

March  20.  Account  sales  sent  to  consignor  covering  sales  as 
follows: 

To  MuUer  Shade  Co.: 

100  Adjustable  Shades  at  $3.00  (check  inclosed)         300.00 
Make  out  the  account  sales  and  make  the  necessary  entries. 
Accoimt  sales  received  from  the  Swanson  Furniture  Co. : 

Oriental  rugs  $4, 200 .  00 

Commission  (10%)  420.00 

Proceeds  (check  inclosed)  $3,780.00 

Received  account  sales  from  the  Smithson  Hardware  Co.  as 
follows: 

25  O.  K.  Chums  at  $6.00  $150.00 

Commission  (75  cents)  18.75 

Proceeds  (check  inclosed)  $131 .  25 

Received  accovmt  sales  from  the  Mason  Furniture  Co.  as  follows: 

15  Universal  FUing  Cabinets  at  $50.00        $750.00 
Commission  7  5  •  00 

Proceeds  (check  inclosed)  $675.00 

Martindale  Furniture  Co.  dishonor  their  30-day  $500.00  note. 

March  22.  Payments  are  made  from  cash  for  coal  for  the  store, 
$12.00  (general  expense)  and  for  hay,  $15.00. 

The  firm  authorizes  the  Swanson  Furniture  Co.  to  sell  the  re- 
mainder of  rugs  at  a  reduction  of  20%  on  the  sale  price.  A  sale  is 
advertised  at  a  cost  of  $5.00  to  the  Swanson  Furniture  Co.  which  is 
charged  against  the  shipment.  The  remaining  rugs  are  sold  and  an 
account  sales  received.  Make  the  appropriate  entries.  (Check  also 
received.) 

(a)   Received  to  be  sold  on  consignment: 

100  Universal  Dictionary  holders  from  the  Central  Fumitvu-e  Co., 
Reedville,  Mich.,  to  be  sold  at  $5.00  on  commission  of  10%.  The 
freight  bill  from  Michigan  Valley  Railroad  Co.  for  $5.00  was  duly 
approved  and  entered.  The  drayage  of  $1.00  was  paid  to  the  Valley 
Transfer  Co. 


290  ACCOUNTING  PRINCIPLES 

(b)  Received  from  the  same  company  another  consignment  con- 
sisting of  50  No.  3  Jewel  Fireless  Cookers  to  be  sold  at  $15.00  on  a 
commission  of  1 2 J^%. 

(c)  Shipped  to  the  Mason  Furniture  Co.  100  additional  Universal 
filing  cabinets  costing  $30.00  each,  to  be  sold  for  $50.00  each  on  a 
commission  of  10%.  The  freight  bill  from  the  \''alley  Central  Rail- 
road was  $7.50  and  the  crating  was  $25.00.  Credit  Valley  Storage 
Co.  for  this  amoimt. 

(d)  Shipped  to  the  Smithson  Hardware  Co.  60  O.  K.  Chums  cost- 
ing $4.00  each  to  be  sold  at  $6.00  on  a  commission  of  75  cents  each. 
The  freight  of  $4.00  was  paid  to  the  \'aUey  Central  Railroad  Co.  and 
the  crating  bill  of  $2.50  was  paid  to  the  Valley  Storage  Co. 

March  23.  The  polic>'  of  paying  the  railroad  fare  of  customers 
from  surroimding  towns  is  adopted  and  a  check  of  $25.00  is  given  to 
the  Valley  Commercial  Association  for  this  purpose.  (Advertising.) 
A  check  for  $60.00  is  also  given  to  the  Stoddard  Poster  Co.  to  pay  for 
advertising  in  surroimding  towns. 

March  24.  A  check  is  given  the  Valley  Central  Railroad  for  $55.34 
to  pay  the  freight  bills  not  charged  to  the  Company. 

The  payroll  for  the  week  was  disbiursed. 

March  26.  Furniture  in  stock  was  repaired  by  the  Rapid  Repair 
Co.  at  a  charge  of  $30.00.  $25.00  is  charged  to  General  Exp>ense  and 
$5.00  is  charged  to  the  Haywood  Furniture  Co.  because  of  their 
carelessness  in  packing. 

Wilson  invoice  March  16  is  paid,  discount  taken  being  $120.00. 

March  28.  Office  supplies  are  purchased  from  the  Comer  Book 
Store  for  cash,  $25.00. 

A  desk  costing  $35.00  is  taken  for  office  use.  (Credit  furniture 
inventory  or  purchases.) 

March  29.  In  coimting  the  cash  for  the  day,  it  is  found  that  there 
is  a  shortage  of  $1.50. 

Sold  the  following  and  rendered  accoimt  sales  inclosing  cash  due 
consignor: 

50  Universal  dictionary  holders  at  $5.00  $250.00 

25  No.  3  Jewel  Fireless  Cookers  at  $15.00  375  00 

Received  accoimt  sales  from  Mason  Furniture  Co.  as  follows: 

50  Universal  Filing  Cabinets  at  $50.00  $2,500.00 

Cartage  2 .  50 

Commission  250.00        252.50 

Balance  due  consignor  (check  inclosed)  $2,247  •  S© 

Received  accoimt  sales  from  Smithson  Hardware  Co.  as  follows: 


$300.00 

0.50 

I -SO 

37  SO 

39  50 

TRANSACTIONS  FOR  MARCH  291 

50  0.  K.  Churns  at  $6.00 

Warehouse  charge 

Drayage 

Commission 

Balance  due  consignor  (check  inclosed)  $260.00 

March  30.  The  People's  Electric  Co.  is  paid  $26.00,  covering 
light  for  the  store  for  the  month. 

March  31.  The  sales  for  the  month  have  been  as  follows:  (Sales 
are  listed  all  at  one  time  to  shorten  the  routine  of  entering  them.  In 
actual  business,  of  course,  they  would  have  been  entered  as  they 
were  made.) 

Cash  sales:  furniture,  $1,500.00;  carpets,  $1,400.00. 

Credit  sales: 


Name 

Furniture 

Carpets 

St.  Luke  Hospital 

$750.00 

$300.00 

Foster  Hall 

500.00 

300.00 

Randolph  Furniture  Co. 

800.00 

400.00 

Smith  Institute 

200.00 

800.00 

J.  H.  Brigham 

150.00 

75.00 

A.  W.  Martin 

225.00 

5500 

Fulton  Furniture  Co. 

500.00 

350.00 

Rice  Mfg.  Co. 

200.00 

50.00 

Newsome  Furniture  Co. 

1,000.00 

1,500.00 

George  Cary,  whose  check  was  dishonored  on  the  7  th,  has  gone 
into  bankruptcy,  and  a  settlement  of  claim  is  made  at  50%. 

The  Martindale  Co.  pays  one  half  the  amount  of  their  dishonored 
note,  with  promise  of  payment  of  the  remainder  shortly. 

The  payroll  is  disbursed. 


Adjusting  and  Closing  Entries  for  March 

z.  Adjustments: 

(c)  For  depreciation.  The  allowance  for  depreciation  is  the 
same  as  for  February,  2%  on  the  cost  of  delivery  equipment, 
and  2%  of  the  cost  of  store  and  oflEice  furniture,  and  3^  of  1% 
on  buildings. 

{b)  For  unexpired  insurance.  The  insurance  cost  for  the 
month  is  the  same  as  for  February. 

(c)  For  interest  on  partners'  loans  and  withdrawals.  The  in- 
terest to  date  on  the  loan  from  Frank  Williams  ($12.50)  should 


292  ACCOUNTING  PRINCIPLES 

be  charged  to  interest  and  credited  to  Frank  Williams,  per- 
sonal. 

(d)  For  accrued  interest  on  notes  receivable.  At  the  begin- 
ning of  the  month  the  amount  of  accrued  interest  on  notes  re- 
ceivable was  carried  as  an  asset.  This  accrued  interest  now  on 
the  books  corresponds  exactly  to  an  inventory  of  merchandise. 
In  closing  the  books  for  March,  this  "inventory"  of  March  i 
must  be  deducted  from  the  interest  received  during  the  month. 
This  deduction  is  made  by  closing  accrued  interest  into  in- 
terest by  an  entry  debiting  interest  and  crediting  accrued  in- 
terest. It  is  then  necessary  to  place  the  new  inventory  of 
accrued  interest  on  the  books.  This  is  done  by  an  entry 
debiting  accrued  interest  and  crediting  interest. 

(e)  For  interest  accrued  on  notes  payable.  At  the  begin- 
ning of  March  there  was  a  hability  inventory  for  interest  ac- 
crued. This  Uabihty  inventory  must  be  closed  into  interest 
and  the  new  inventory  of  interest  accrued  on  March  31  placed 
on  the  books.  (Note  that  the  entries  to  adjust  the  books  for 
interest  accrued  on  notes  payable  are,  as  one  might  naturally 
expect,  the  reverse  of  the  entries  to  adjust  the  books  for  ac- 
crued interest  on  notes  receivable.) 

2.   Determining  Gross  Profit  on  Sales : 

In  previous  work  the  gross  profit  has  been  shown  in  trading. 
This  month  gross  profit  is  shown  in  sales  rather  than  in  trad- 
ing, (i)  Gross  profit  is  shown  in  sales  rather  than  in  trading 
so  frequently  that  it  is  desirable  that  one  become  familiar  with 
both  plans;  (2)  when  gross  profit  is  shown  in  sales  it  is  possible 
to  determine  the  profit  on  each  class  of  goods  sold,  easily.  The 
steps  in  closing  the  merchandise  accounts  when  gross  profit  is 
shown  in  sales  are  these: 

(i)  Purchase  returns  and  sales  returns  are  dosed  into  pur- 
chases and  sales. 

(2)  Freight-in  is  closed  into  purchases.  Since  freight  on 
both  carp>ets  and  furniture  has  been  charged  to  one  accoimt,  it 
is  necessary  now  to  divide  the  cost  of  freight  between  carpet 
and  furniture  purchases  on  some  equitable  basis.  An  exami- 
nation of  the  freight  bills  shows  that  for  this  month  an  ap- 


TRANSACTIONS  FOR  MARCH  293 

proximate  division  of  freight  charges  on  the  basis  of  4/5  to 
furniture  and  1/5  to  carpets  is  equitable. 

(3)  The  inventories  of  March  i  are  closed  into  purchases. 

(4)  The  new  inventories  of  March  31  are:  furniture,  $35,- 
265.70;  carpets,  $10,256.47. 

(5)  The  purchase  accounts  now  show  the  cost  of  the  goods 
sold.  The  sales  accounts  show  the  net  sales.  When  purchases 
are  closed  into  sales,  the  balance  of  each  sales  account  shows 
the  gross  profit  on  the  sale  of  the  goods. 

QUESTIONS  AND  PROBLEMS 

1.  What  are  generally  the  liabilities  of  the  consignee  and  the  consignor 
in  the  sale  of  goods  through  a  consignee? 

2.  What  record  should  a  consignee  make  when  goods  are  received  to  be 
sold  on  consignment? 

3.  If  cash  and  credit  sales  of  consignment  goods  are  entered  in  the  sales 
journal  and  posted  therefrom  to  the  respective  ledger  accounts,  indicate  the 
necessary  form  of  sales  journal. 

4.  What  are  the  debits  and  credits  to  the  consignment  account,  and  from 
what  books  are  they  commonly  posted? 

5.  Describe  the  content  of  an  account  sales. 

6.  What  information  is  needed  by  the  consignor  in  regard  to  the  opera- 
tions of  the  consignee? 

7.  Give  the  debits  and  credits  to  the  shipment  profit  and  loss. 

8.  What  provision  is  made  for  the  maintenance  of  a  control  over  the 
consignment  inventories  in  the  hands  of  consignees? 


CHAPTER  XXI 
THE  INCOMING  AND  WITHDRAWAL  OF  PARTNERS 

1.  Articles  of  Partnership.  —  If  two  or  more  individuals  carry 
on  a  business  together  and  hold  themselves  out  as  partners,  a 
partnership  exists,  even  though  there  are  no  formal  articles  set- 
ting forth  the  rights  and  duties  of  the  partners.  The  act  of 
carrjTng  on  the  business  together  and  of  sharing  in  the  man- 
agement and  profits  is  suflBcient  in  itself  to  establish  the  part- 
nership relation.  In  short,  articles  of  partnership  are  not  es- 
sential to  the  existence  of  a  general  partnership. 

It  is  advisable,  however,  in  most  instances,  to  have  a  definite 
partnership  agreement,  in  order  to  place  proper  limits  on  the 
rights  and  duties  of  the  partners  in  the  conduct  of  the  business. 
For  an  accountant,  such  an  agreement  has  jmrticular  interest, 
because  its  provisions  usually  affect  the  natiu-e  of  the  business 
to  be  done,  the  character  of  the  accounts  to  be  kept,  the  divi- 
sion of  the  profits  and  the  losses,  the  compensation  of  the  j)art- 
ners,  the  interest  to  be  allowed  on  the  investments  of  the  part- 
ners, the  distribution  of  the  managerial  functions  between  or 
among  the  partners,  the  j>eriod  between  closings  and  audits, 
and  the  dissolution  of  the  partnership.  The  articles  of  partner- 
ship should  be  read,  therefore,  before  any  accounting  records 
are  op)ened,  or  before  any  audit  is  made  of  the  books.  It  need 
hardly  be  said  that  a  law>^er  rather  than  an  accountant  is  the 
logical  pjerson  to  draft  the  partnership  agreement. 

2.  Books  of  the  Partnership.  —  The  capital  accounts  of  the 
partners  and  their  relation  to  the  other  accoimts  constitute  the 
chief  problems  of  p)artnership  accounting.  The  capital  accounts 
of  a  partnership  are,  of  course,  similar  to  the  capital  account  of 
an  individually  owned  business.  They  are  credited  with  the 
resj)ective  shares  of  the  partners  in  the  profits  of  the  business, 

2<H 


THE   INCOMING  AND   WITHDRAWAL  OF  PARTNERS     295 

and  are  charged  with  the  debit  balances  of  the  respective  per- 
sonal accounts  at  the  time  of  closing.  The  other  accounts  to 
be  set  up  and  the  general  books  of  record  to  be  kept  are  iden- 
tical with  those  of  an  individual  concern  of  similar  size. 

3.  Admission  of  Partner  without  Goodwill  Allowance.  —  A 
partnership  is  frequently  formed  by  the  owner  of  an  individual 
concern  to  increase  the  investment  in  the  business  and  at  the 
same  time  to  bring  into  the  concern  a  man  competent  to  assist 
in  its  management.  Before  a  partner  is  thus  admitted,  it  is 
necessary  to  close  the  accounts  of  the  existing  firm  and  to  de- 
termine the  conditions  of  the  partnership  arrangement.  One  of 
the  most  important  questions  to  be  decided  is  the  basis  upon 
which  profits  and  losses  are  to  be  shared.  If  no  agreement  is 
made  covering  this  point,  the  profits  and  losses  are  shared 
equally.  Of  similar  importance  is  the  question  of  the  capital 
interest  the  incoming  partner  acquires  through  his  investment 
in  the  business. 

4.  Capital  Interest  Acquired.  —  (a)  The  simplest  arrange- 
ment is  obviously  to  give  to  the  original  owner  a  capital  equal 
to  the  amount  at  which  his  capital  stood  at  the  time  of  the 
closing  of  his  individual  books,  and  to  give  to  the  incoming 
partner  an  interest  equal  to  the  cash  or  property  value  which 
he  contributes  to  the  new  concern.  If  we  assume  that  this 
amount  is  $5,000.00  and  that  the  old  books  are  continued,  the 
admission  of  the  new  partner  is  recorded  by  the  following  jour- 
nal entry: 

Cash  5,000.00 

John  Smith,  Capital  5,000.00 

Investment  of  John  Smith  as  a  part- 
ner in  the  business 

(b)  The  case  is  not  different  in  principle  if  the  incoming 
partner  contributes  other  forms  of  property  in  addition  to  cash 
and  the  business  of  the  new  concern  is  carried  on  under  the  old 
firm  name.  If  his  assets,  liabilities,  and  capital  are  accepted 
by  the  new  concern  at  the  figures  shown  on  his  own  books  of 
record,  the  journal  entry  marking  his  engagement  in  the  part- 
nership relation  becomes  the  following: 


296  ACCOUNTING  PRINCIPLES 

Siindry  Assets  (Detailed)  io,ocx) .  00 

Sxindry  Liabilities  (Detailed)  5,cx».cx> 

John  Smith,  Capital  5,000.00 

Assumption  of  the  assets  and  liabili- 
ties of  John  Smith  as  a  partner  in 
in  the  business 

This  entry  on  the  books  of  the  partnership  is  clearly  identical 
in  form  with  the  opening  entry  on  the  books  of  an  individual 
business  where  the  assets  and  liabilities  of  another  concern  are 
taken  over. 

(c)  Frequently,  when  a  partner  is  taken  into  a  business,  his 
assets  are  revalued  by  the  firm  of  which  he  is  to  become  a 
member.  Where  such  is  the  case,  the  books  of  the  incoming 
partner  must  be  readjusted  so  as  to  bring  his  record  of  asset 
balances  to  the  amoimt  agreed  upon  as  their  transfer  value.  If 
a  series  of  readjustments  must  be  made,  it  is  advisable  to  open 
an  adjustment  account.  Any  reductions  in  asset  valuations  are 
then  charged  to  this  account  and  credited  to  the  assets  affected. 
After  the  necessary  readjustments  have  been  made,  the  account 
is  closed  into  capital. 

Let  us  suppose,  for  example,  that  the  furniture  and  fixtures 
account  is  to  be  reduced  by  $75.00,  the  inventor}'  account  by 
$150.00  and  accoimts  receivable  by  $100.00.  All  three  read- 
justments may  be  placed  on  the  books  by  the  following  journal 
entry: 

Adjustments  325.00 

Furniture  and  Fixtures  75  00 

I       Inventory  150.00 

Accoimts  Receivable  100 .  00 

Adjustment  of  asset  balances 

After  the  necessary  postings  have  been  made,  the  adjustment 
account  is  dosed  into  the  capital  account,  as  follows: 

John  Smith,  Capital  325.00 

Adjustments  3  2  5 .  00 

Closing  of  adjvistments  into  capital 

Where  the  members  of  a  partnership  are  taken  in  as  partners 
in  another  concern,  the  adjustment  account  must  be  appor- 


THE  INCOMING  AND   WITHDRAWAL  OF  PARTNERS     297 

tioned  to  their  respective  capital  accounts  in  the  old  firm.  In 
such  cases,  the  adjustment  account  represents  a  material  sav- 
ing; for,  if  each  reduction  in  assets  were  to  be  distributed  as  a 
loss  to  the  several  partnership  accounts,  the  number  of  such 
distributions  would  be  limited  only  by  the  number  of  items  to 
be  readjusted. 

After  the  required  adjustments  and  closings  have  been  made, 
a  new  balance  sheet  is  drawn  up  to  serve  as  the  basis  for  the 
transfer  of  the  assets  and  liabilities  at  the  agreed  valuation. 
The  items  are  actually  entered  on  the  books  of  the  new  firm  in 
the  manner  set  forth  in  (b)  above. 

An  incoming  partner  not  infrequently  demands  that  adjust- 
ments be  made  in  the  valuation  of  the  assets  and  liabilities  of 
the  business  of  which  he  is  to  become  a  member.  If  the  new 
firm  created  by  his  admission  uses  the  same  books  of  record 
employed  by  the  old  concern,  the  readjusting  entries  are  placed 
on  the  books  of  the  old  firm  in  a  manner  similar  to  that  illus- 
trated in  (c)  above.  The  revised  balance  sheet  is  then  recorded 
on  the  books  of  the  new  business,  and  in  conjimction  with  the 
balance  sheet  of  the  business  taken  over  serves  as  the  basis  for 
the  opening  entry  of  the  new  concern  in  connection  with  the 
admission  of  the  additional  partner. 

5.  Admission  of  Partner  with  Goodwill  Allowance.  —  Good- 
will is  not  recorded  on  the  books  of  a  partnership  unless  its 
value  is  definitely  determined  through  some  transaction  con- 
nected with  the  admission  or  withdrawal  of  a  partner.  During 
the  early  period  of  its  existence,  a  business  is  usually  regarded  as 
fortunate  if  an  ordinary  return  is  received  on  the  actual  invest- 
ment of  the  owners.  After  the  business  has  been  in  operation 
for  a  period  of  years,  it  not  infrequently  earns  a  larger  return 
than  that  commonly  made  on  the  amount  invested.  This  larger 
return  is  due,  of  course,  to  an  increased  volume  of  business 
which  the  firm  has  secured  through  the  good  management  of 
the  enterprisers.  Since  these  larger  profits  are  usually  secured 
only  after  a  more  or  less  extended  period  of  operation,  goodwill 
is  sometimes  calculated  as  worth  four  or  five  times  the  average 
annual  net  profits  of  the  business,  on  the  assumption  that  this 


298  ACCOUNTING  PRINCIPLES 

length  of  time  is  required  to  place  the  business  on  a  good  earn- 
ing basis.  A  more  common  basis  of  calculating  goodwill  is  to 
capitalize  the  excess  of  the  average  annual  net  profits  for  a 
short  period  of  years  beyond  what  is  regarded  as  a  reasonable 
return  on  the  actual  business  investment.  These  considera- 
tions, however,  have  largely  to  do  with  the  basis  upon  which 
the  partners  proceed  in  the  determination  of  goodwill. 

Let  us  assume  that  John  Smith  has  a  capital  of  $5,000.00, 
and  that  he  sells  a  half  interest  to  John  Doe  for  $3,000.00,  the 
money  being  paid  to  Smith  personally  and  not  to  the  business 
in  which  Doe  becomes  a  partner.  If  the  business  of  John  Smith 
is  worth  $5,000.00,  manifestly  a  half  interest  should  sell  for 
$2,500.00.  The  $500.00  excess  may  be  regarded  as  a  payment 
for  goodwill.  A  conservative  rule,  much  advocated,  requires 
that  goodwill  be  placed  on  the  books  only  when  it  has  been 
purchased  by  the  business.  In  this  transaction  there  has  been 
no  purchase  of  goodwill,  but  its  market  value  may  be  regarded 
as  established  at  $1,000.00  through  the  paj-ment  of  $500.00  for 
a  half  interest  therein.  If  this  reasoning  is  adopted,  the  trans- 
action is  journalized  as  follows: 

Goodwill  1,000.00 

John  Smith,  Capital  2,000.00 

John  Doe,  Capital  3.000.00 

Purchase  of  half  interest  in  the  busi- 
ness by  John  Doe  through  pay- 
ment to  John  Smith  of  $3,000.00 
cash 

If  the  more  conservative  practice  is  followed  of  avoiding  an 
entry  to  the  debit  of  goodwill  unless  actually  purchased,  the 
journal  entry  becomes  the  following: 

John  Smith,  Capital  2,500.00 

John  Doe,  Capital  2,500.00 

Piurchase  of  half  interest  in  the  busi- 
ness by  John  Doe  through  pay- 
ment to  John  Smith  of  $3,000.00 
cash 

Let  us  suppose  that,  instead  of  paying  $3,000.00  to  John 
Smith  personally  for  a  half  interest  in  his  business,  John  Doe 


THE   INCOMING  AND   WITHDRAWAL  OF  PARTNERS     299 

contributes  $6,000.00  to  the  business  itself  for  a  half  interest 
therein.  This  transaction  may  be  assumed  to  establish  a  $1,- 
000.00  value  for  the  goodwill  of  the  business,  and,  if  the  good- 
will entry  is  allowed,  is  journalized  as  follows: 

Cash  6,000 .  00 

John  Doe,  Capital  6,000 .  00 

Purchase  of  half  interest  in  the  busi- 
ness of  John  Doe 

Goodwill  1,000.00 

John  Smith,  Capital  1,000. od 

Credit  for  goodwill  established  in  con- 
nection with  admission  of  John 
Doe  as  partner  with  a  half  inter- 
est allowance  of  $6,000.00 

Under  more  conservative  treatment,  the  transaction  is  recorded 
by  means  of  the  following  entry: 

Cash  6,000 .  00 

John  Doe,  Capital  5,500.00 

John  Smith,  Capital  500.00 

Purchase  of  half  interest  in  the  busi- 
ness by  John  Doe  for  $6,000.00 

If  instead  of  merely  cash  John  Doe  brings  into  the  new  con- 
cern a  business  of  his  own,  it  is  entirely  possible  for  him  to  re- 
ceive an  allowance  for  goodwill  instead  of  consenting  to  such  an 
allowance  to  the  firm  with  which  he  becomes  connected.  If  he 
is  given  a  $5,000.00  interest  for  an  asset  contribution  of  $4,- 
000.00,*  the  new  concern  is  making  a  goodwill  purchase  of 
$1,000.00  and  crediting  the  amount  to  the  capital  account  of 
the  incoming  partner.  Such  a  procedure  represents  the  con- 
servative practice  of  placing  goodwill  on  the  books  at  the  actual 
cost  price. 

Let  us  now  suppose  that  John  Doe  becomes  a  half- 
interest  partner  by  the  simple  payment  of  $4,000.00  cash. 
If  no  compensating  allowance  is  to  be  made,  the  admis- 
sion of  the  new  partner  is  recorded  by  the  following  journal 
entry: 


300  ACCOUNTING  PRINCIPLES 

Cash  4,000.00 

John  Smith,  Capital  500.00 

John  Doe,  Capital  4,500.00 

Purchase  of  half  interest  in  the  busi- 
ness by  John  Doe  for  $4,000.00 

Such  an  entry,  however,  in  view  of  the  goodwill  entries  made 
above,  is  easily  open  to  criticism  for  not  still  further  reducing 
the  capital  account  of  John  Smith.  If  a  partner  buys  a  half 
interest  for  $4,000.00,  on  what  ground  can  it  be  urged  that  the 
whole  business  is  worth  more  than  double  this  sum?  Does  not 
the  sale  demonstrate  that  the  market  value  of  the  assets  of  the 
old  business  has  decreased  by  $1,000.00?  In  other  words,  if  the 
payment  of  $6,000.00  for  a  half  interest  established  a  goodwill 
asset  of  $1,000.00,  why  does  not  the  payment  of  $4,000.00  for 
a  half  interest  give  rise  to  a  shrinkage  charge  of  $1,000.00 
against  the  value  of  the  business  assets?  Such  a  shrinkage  can, 
of  course,  be  set  up  by  a  journal  entry,  as  follows: 

Shrinkage  in  Value  of  Total  Assets     1,000.00 

Goodwill  Depreciation  Reserve  1,000.00 

Creation  of  depreciation  reserve  to  re- 
cord decrease  n  value  of  business 
as  a  whole 

The  amount  of  the  shrinkage  is  then  charged  to  John  Smith 
by  the  following  additional  entry: 

John  Smith,  Capital  1,000.00 

Shrinkage  in  Value  of  Total  Assets  i;ooo.oo 

Charge  to  capital  of  decrease  in  busi- 
,         ness  goodwill 

The  result  of  these  two  entries  is  to  produce  the  following 
modification  of  the  partnership  record : 

Cash  4,000.00 

John  Doe,  Capital  4,000 .  00 

Purchase  of  a  half  interest  in  the  busi- 
ness by  John  Doe  through  the 
contribution  of  $4,000.00  cash 

Some  question  may  well  be  raised,  however,  concerning  the 
conclusion  that  the  payment  of  an  amount  less  or  greater  than 


THE  INCOMING  AND  WITHDRAWAL  OF  PARTNERS    30 1 

the  total  assets  establishes  a  goodwill  item  as  definitely  as  the 
entries  seem  to  indicate.  On  the  one  hand,  the  incoming  part- 
ner may  be  midesirable  as  a  counselor,  because  of  his  short  ex- 
perience or  lack  of  training.  In  such  a  case,  the  extra  charge 
may  not  be  wholly  a  question  of  goodwill.  On  the  other  hand, 
a  payment  of  less  than  half  the  value  of  the  total  assets  for  an 
equal  interest  in  the  business  may  be  an  indication  of  a  high 
estimation  of  the  ability  and  experience  of  the  incoming  part- 
ner. It  is  questionable,  therefore,  whether  the  tendency  to  de- 
part from  conservative  practice  and  to  place  goodwill  on  the 
books  when  it  has  not  been  purchased,  is  justified  as  a  general 
rule.  Such  deviations  may  be  proper  as  exceptions  if  the  facts 
clearly  demonstrate  that  a  fairer  valuation  would  result  from 
their  use.  In  any  event,  they  should  be  allowed  only  after  very 
careful  analysis  of  each  particular  case. 

6.  Purchase  of  Interest  of  Retiring  Partner.  —  A  goodwill 
item  may  well  arise  through  the  purchase  of  the  interest  of  a 
retiring  partner.  If  partner  A,  having  an  interest  of  $5,000.00, 
is  allowed  this  amount  by  the  remaining  firm  member  out  of 
the  funds  of  the  business,  the  retirement  of  A  from  the  concern 
is  recorded  by  means  of  the  following  journal  entry: 

A,  Capital  5,000.00 

Cash  •  5,000.00 

Allowance  to  A  of  the  book  value  of 

his  interest  upon  his  retirement 

from  the  firm 

If,  however,  A  is  allowed  $5,500.00  for  his  interest  upon  retire- 
ment, the  transaction  may  be  journalized  as  follows: 

A,  Capital  ,5,000.00 

Goodwill  500 .  00 

Cash  5,500.00 

Allowance  to  A  of  $500.00  in  excess  of 

the  book  value  of  his  interest 

upon  his  retirement  from  the  firm 

If  it  is  assumed  that  B's  interest  in  the  firm  is  also  $5,000.00, 
it  becomes  fair  to  argue  that  the  purchase  of  an  equal  partner's 
interest  at  $500.00  in  excess  of  its  book  value  must  establish 


302  ACCOUNTING  PRINCIPLES 

$1,000.00  as  the  worth  of  the  entire  goodwill  of  the  business. 
If  this  interpretation  is  accepted,  the  transfer  of  ^'s  interest  to 
B  may  be  recorded  by  the  following  entry: 

A,  Capital  5,000.00 
Goodwill  1 ,000 .  00 

B,  Capital  500.00 

Cash  5,500.00 

Allowance  to  A  of  $500.00  in  excess  of 
the  book  value  of  his  interest 
upon  his  retirement  from  the  firm 

In  the  foregoing  argument,  it  has  been  assumed  that  goodwill 
is  attached  to  the  business  and  not  to  the  individual.  It  is 
probably  true,  however,  that  goodwill  is  to  some  extent  a  per- 
sonal matter,  and  that  in  going  away  from  the  firm  A  does  not 
transfer  aU  of  his  goodwill  to  the  concern.  This  fact  is  ordi- 
narily taken  into  consideration  by  the  remaining  members  of 
the  firm  in  the  negotiations  for  the  interest  of  the  retiring  part- 
ner. Moreover,  the  personaUty  and  reputation  of  an  incom- 
ing partner  would  have  a  bearing  on  whether  he  would  be  al- 
lowed a  half  interest  at  a  price  in  excess  of  the  capital  interest 
already  existing  or  at  a  lower  figure. 

Strictly  speaking,  of  course,  there  has  been  no  purchase  of 
goodwill  by  the  business  in  the  transaction  assumed  above,  the 
goodwill  of  the  firm  after  A^s  retirement  being  no  greater  than 
it  was  before.  Consequently,  ultra-conservative  practice  re- 
quires the  elimination  of  the  goodwill  item  in  the  journal  entry, 
thereby  forcing  it  to  assume  the  following  form: 

.4,  Capital  5,000.00 

B,  Capital  500.00 

Ca^  5,500.00 

Allowance  to  A  of  $500.00  in  excess  of 
the  book  value  of  his  interest 
upon  his  retirement  from  the  firm 

Let  us  suppose  now  that  A  received  only  $4,500.00  for  his 
$5,000.00  interest  in  the  business.  If  no  consideration  is  given 
to  the  matter  of  goodwill,  the  transaction  is  journalized  as  fol- 
lows: 


THE  INCOMING  AND  WITHDRAWAL  OF  PARTNERS    303 

A,  Capital  5,000.00 

Cash  4,500.00 

B,  Capital  500.00 

Purchase  of  ^'s  $5,000.00  interest  by 
B  for  $4,500.00  cash 

As  a  result  of  this  entry,  B's  capital  would  be  increased  to 
$5,500.00.  In  all  probability,  however,  the  sale  of  A's  inter- 
est for  $4,500.00  indicated  that  this  particular  half  interest  was 
worth  less  than  its  recorded  book  value.  It  would  seem  to  fol- 
low that  5's  half  interest  is  also  worth  less  than  its  book  value 
in  a  corresponding  ratio.  To  establish  the  actual  market  valu- 
ation of  the  proprietorship  interest  in  the  concern,  the  follow- 
ing entry  may  be  made: 

Shrinkage  in  Value  of  Total  Assets        1,000 .  00 

Goodwill  Depreciation  Reserve  1,000.00 

Creation  of  depreciation  reserve  to 

record  decrease  in  value  of  the 

business  as  a  whole 

This  shrinkage  should,  of  course,  be  borne  by  the  partners  alike 
as  follows: 

^'s  Capital  500.00 

.B's  Capital  500 .  00 

Shrinkage  in  Value  of  Total  Assets  1,000.00 

•  Charge  to  capital  accounts  of  decrease 
in  business  goodwill 

The  entry  recording  ^'s  retirement  from  the  concern  then  be- 
comes: 

A's  Capital  4,500.00 

Cash  4,500.00 

Purchase   of  ^'s    half   interest    for 
4,500.00   ash 

This  latter  treatment  does  not  represent  established  account- 
ing practice.  It  is  given  merely  for  the  purpose  of  carrying  out 
a  logical  program  of  setting  up  book  values  for  partnership  as- 
sets on  the  basis  of  the  price  established  for  these  assets  through 
the  sale  of  an  interest  in  the  concern.  The  sale  of  an  interest 
cannot,  of  course,  be  relied  upon  with  assurance  to  define  the 


304  ACCOUNTING  PRINCIPLES 

market  price  of  the  entire  proprietorship  interest.  There  are 
frequently  factors  affecting  the  market  price  of  a  part  interest 
which  would  not  necessarily  apply  to  the  interest  as  a  whole. 

A  consideration  of  the  various  possibilities  in  the  sale  of  a 
part  interest  in  a  business  throws  doubt  on  the  propriety  of  the 
whole  series  of  entries  in  which  a  goodwill  value  is  regarded  as 
established  by  the  sale  of  an  interest  either  to  the  concern  it- 
self or  to  an  incoming  partner  The  old  rule  of  not  allowing 
an  entry  of  goodwill  on  the  books  unless  actually  purchased 
by  the  business  should  be  strictly  adhered  to,  except  where 
the  particular  circumstances  clearly  indicate  that  a  different 
entry  would  more  fairly  represent  the  facts. 

QUESTIONS  AND   PROBLEMS 

1.  What  are  the  tests  in  r^ard  to  the  existence  of  a  general  partnership? 

2.  WTiat  subjects  should  articles  of  partnership  cover? 

3.  With  what  particular  accoimts  are  the  chief  problems  of  partnership 
accounting  connected? 

4.  If  a  partner  comes  into  the  business  without  provision  as  to  how  the 
profits  and  losses  will  be  divided,  how  are  profits  and  losses  shared? 

5.  What  is  the  use  of  an  adjustment  accoimt?  What  items  are  debited 
to  it  and  what  items  are  credited? 

6.  How  is  goodwill  created? 

7.  On  what  basis  is  goodwill  calculated? 

8.  What  is  the  conser\ative  rule  in  relation  to  the  price  at  which  good- 
will should  be  placed  on  the  books? 

9.  On  what  other  basis  than  purchase  price  is  goodwill  frequently  entered 
on  partnership  books? 

10.  A  and  B  are  equal  partners  with  an  investment  of  $20,000  each. 
They  desire  to  secure  additional  capital  with  which  to  extend  the  business 
and  agree  to  admit  C  as  an  equal  partner  on  the  pa>Tnent  of  $14,000  into 
the  firm.  Give  the  entries  to  record  the  admission  of  C,  (i)  keeping  an 
account  with  goodwill,  and  (2)  eliminating  goodwill  from  the  accoimts. 

11.  X  and  Y  are  p>artners  with  an  investment  of  $20,000  each.  The 
business  is  highly  prosperous.  Z  is  admitted  as  an  equal  partner  on  the 
j)ayment  of  $25,000  into  the  firm.  Give  the  entries  to  record  the  admission 
of  Z,  (i)  keeping  an  account  with  goodwill,  and  (2)  eliminating  goodwill 
from  the  accounts. 

12.  D  has  invested  $15,000  in  a  business.  He  agrees  to  sell  to  E  a  one- 
half  interest  in  the  business  as  it  stands  for  $8,000.  Give  the  entries  to 
admit  E  to  the  partnership,  assuming  the  keeping  of  an  account  with  good- 
wiU. 


CHAPTER  XXII 
DISTRIBUTION  OF  THE  PARTNERSHIP  PROFITS 

I.  Basis  of  Distribution.  —  Although  the  partners  are  in  a 
certain  sense  creditors  of  the  firm  in  which  they  hold  a  control- 
ling interest,  one  of  the  primary  characteristics  of  a  partner- 
ship is  that  the  claims  of  outside  creditors  outrank  those  of  the 
partners  themselves.  The  partners  may  create  priorities  affect- 
ing the  funds  which  they  themselves  contribute,  but  they  can- 
not create  claims  for  themselves  against  the  assets  or  income  of 
the  business  superior  to  those  of  outside  creditors.  For  instance, 
the  partners  may  agree  that  each  shall  be  entitled  to  a  definite 
wage,  to  be  charged  as  a  part  of  the  operating  expenses,  before 
there  is  any  distribution  of  the  profits.  This  agreement  holds 
so  far  as  the  claims  of  the  partners  are  concerned,  but  does 
not  affect  the  priority  of  outside  claims  if  the  gross  income  is 
insuflicient  to  meet  all  of  the  operating  expenses  of  the  business. 
As  owners  of  the  business,  the  partners  may  set  up  a  series 
of  mortgages  or  priorities  affecting  the  rank  of  the  liabilities 
as  well  as  a  similar  series  of  priorities  with  respect  to  their  own 
claims.  They  cannot,  however,  make  their  partnership  claims 
superior  to  those  of  outside  parties.  In  other  words,  the  in- 
come of  a  general  partnership  must  be  used  first  to  meet  the 
outside  liabilities,  and  then  to  satisfy  the  claims  of  the  part- 
ners themselves.  In  fact,  the  claims  of  outside  creditors  go  be- 
yond the  income  and  assets  of  the  business,  and  become  a 
charge  against  the  personal  assets  of  the  partners,  individually 
as  well  as  collectively. 

2.  Interest  Claims  of  Partners.  —  A  partner  may  lend  money 
to  the  business  and  receive  the  firm's  note  payable,  or  the  capi- 
tal of  each  partner  may  be  fixed  at  a  definite  figure,  with  the 
understanding  that  contributions  in  excess  of  these  amounts 
shall  be  treated  as  loans  upon  which  the  business  is  to  pay  in- 

305 


3o6  ACCOUNTING  PRINCIPLES 

terest.  Conversely,  it  may  be  agreed  that  the  partners  shall 
pay  interest  on  drawings  which  bring  their  investments  below 
the  amounts  fixed  as  their  respective  capital  shares.  While 
these  interest  claims  of  the  partners  against  the  business  may 
be  made  to  rank  ahead  of  their  profit-sharing  claims,  as  ex- 
plained above,  they  must  always  be  subject  to  the  rights  of 
outside  creditors. 

The  note  payable  and  interest  claims  of  the  partners  against 
the  business  are  of  an  entirely  different  character  from  the 
profit-sharing  rights  they  may  hold.  The  partner  who  is  the 
owner  of  one  of  the  firm's  notes  may  legally  compel  an  account- 
ing and,  if  necessary,  a  sale  of  the  assets  to  meet  his  claim.  As 
against  the  other  partners,  the  particular  partner's  claim  car- 
ries with  it  all  the  rights  ordinarily  pertaining  to  such  an  in- 
vestment. 

It  is  frequently  stipulated  in  the  partnership  agreement  that 
each  partner  shall  receive  annually  a  certain  percentage  on  his 
capital  investment  before  there  is  any  distribution  of  the  prof- 
its for  the  year.  Such  a  provision  is  generally  regarded  as  a 
supplementary  device  for  dividing  profits  rather  than  as  a  de- 
vice for  creating  interest  claims  against  the  income  of  the  busi- 
ness. Such  claims  are,  therefore,  treated  as  deductions  from 
the  net  profits  and  not  as  expenses  chargeable  to  income  before 
the  net  profits  are  ascertained.  The  agreement  not  infre- 
quently further  specifies  whether  these  claims  are  to  be  met 
only  in  so  far  as  the  annual  net  profits  may  suflSce,  or  whether 
any  deficit  created  thereby  is  to  be  charged  to  the  capital 
accounts  of  the  partnership  in  the  loss  and  gain  sharing 
ratio. 

These  various  considerations  lead  to  the  following  classifica- 
tions of  the  partnership  interest  claims:  (a)  Interest  to  out- 
side creditors;  (b)  interest  on  partners'  loans;  (c)  interest  on 
partners'  capitals.  As  the  latter  two  classes,  as  well  as  the 
matter  of  interest  on  withdrawals,  are  based  on  the  under- 
standing of  the  partners  themselves,  it  is  of  the  greatest  impor- 
tance that  the  partnership  agreement  should  clearly  define  the 
rights  of  the  partners  in  the  matter  of  the  payment  and  receipt 


DISTRIBUTION  OF  THE  PARTNERSHIP  PROFITS     307 

of  interest  as  well  as  in  the  matter  of  the  distribution  of  losses 
and  gains. 

3.  Distribution  of  Profits.  —  In  the  absence  of  a  definite  un- 
derstanding to  the  contrary,  the  profits  of  a  partnership  are 
divided  equally  between  or  among  the  partners.  Some  of  the 
forms  of  distribution  by  agreement  are  as  follows: 

a.  Distribution  of  Profits  on  Basis  of  Capitals  at  Beginning  of 
Period.  —  If  the  profits  are  to  be  shared  on  a  basis  of  the  capi- 
tals at  the  beginning  of  the  period,  the  partners  should  have  an 
understanding  with  reference  to  drawings  and  to  contributions 
in  excess  of  capital.  Salaries  for  services  and  interest  on  draw- 
ings serve  as  protective  measures  in  this  regard.  Let  us  sup- 
pose that,  under  such  an  arrangement,  the  net  profits  for  the 
year  of  the  firm  of  A  and  B  are  $6,000.00,  ^'s  capital  at  the 
beginning  of  the  period  being  $12,000.00  and  B's  $18,000.00. 
If  the  interest  on  ^'s  drawings  during  the  year  amounts  to 
$150.00,  and  the  interest  on  -B's  drawings  amounts  to  $75.00, 
the  following  capital  charges  must  be  made  before  the  annual 
profits  are  distributed: 


22K.OO 


The  interest  on  drawings  account  is  then  closed  into  profit  and 
loss,  though  not  into  the  section  in  which  the  net  profits  are 
calculated.  This  done,  the  total  profits  of  $6,225.00  are  divided 
in  the  proportion  of  2/5  to  A  and  of  3/5  to  B,  the  distribution 
being  journalized  as  follows: 

Profit  and  Loss — ^Balance  6,225.00 

A's  Capital  2,490.00 

5's  Capital  3>73Soo 

Distribution  of  year's  profits 

The  closing  of  the  principal  section  of  the  profit  and  loss  ac- 
count and  the  opening  of  the  distribution  section  is  effected  by 
the  following  journal  entry: 


^'s  Capital 

150.00 

.B's  Capital 

75.00 

Interest  on  Drawings 

Interest  on  year's  drawings 

3o8  ACCOUNTING  PRINCIPLES 

Profit  and  Loss  —  Net  Profits  6,000 .  00 

Profit  and  Loss  —  Net  Profits  (down) 
Bringing  down  of  net  profits  to  distri- 
bution section  of  account 


6,000.00 


With  this  entry  posted,  the  profit  and  loss  account  will  appear 
as  follows: 

Profit  and  Loss 


1919  1919 

Dec.  31     Sundry    Ex.    15,000.00  Dec.  31     Gross  Profits 

Net  Profits        6,000.00  (down)        21,000.00 

21,000.00  2 1 ,000 .  00 

Dec.  31     Balance    for  Dec.  31     Net  Profits 

Distribution    6,225.00  (down)          6,000.00 

Interest   on 


6,225.00 


Drawings        225.00 
6,225.00 


K  the  two  partners  had  paid  to  the  business  in  cash  the 
amount  of  the  interest  on  their  drawings,  the  payments  would 
have  constituted  an  actual  income  of  the  business.  The  inter- 
est charges  made  above,  however,  merely  serve  to  readjust  the 
profit  distributions,  and  do  not  affect  the  total  amount  to  be 
divided.  Though  the  amount  to  be  distributed  is  apparently 
increased  by  $225.00,  a  like  amount  has  been  deducted  from 
the  capitals  of  the  partners.  The  really  significant  factor  is 
that,  while  the  deductions  were  in  the  ratio  of  2  to  i,  the  addi- 
tions are  in  the  ratio  of  2  to  3.  In  other  words,  although  A 
and  B  together  gain  nothing  by  the  readjustment,  B  suffers 
less  than  A  in  the  deductions  and  acquires  more  than  A  in  the 
distribution. 

b.  Distribution  of  Profits  on  Basis  of  Average  Capital  In- 
vested. —  Let  us  suppose  that,  instead  of  following  the  previous 
plan,  the  partners  agree  to  divide  the  profits  of  the  firm  on  the 
basis  of  the  average  amount  each  has  contributed  during  the 
year,  the  record  of  their  investments  and  withdrawals  beiiig  as 
follows: 


DISTRIBUTION  OF  THE  PARTNERSHIP  PROFITS       309 


Partner  A 

1919 

Investments 

Withdrawals 

January  i 

$10,000.00 

February  i 

1,000.00 

March  i 

$500.00 

April  I 

200.00 

May  I 

400.00 
Partner  B 

1919 

Investments 

Withdrawals 

January  i 

$15,000.00 

February  i 

$500 . 00 

March  i 

300.00 

April  I 

750.00 

July  I 

200.00 

September  i 

1,000.00 

A  simple  method  of  averaging  the  investments  and  withdraw- 
als is  to  reduce  them  to  a  month  equivalent,  as  follows: 


-4 's  Investments: 

$10,000.00  X  12 

$120,000.00 

1,000.00  X  II 

11,000.00 

400.00  X    8 

3,200.00 

Month  Equivalent 

$134,200.00 

^'s  Withdrawals: 

$500.00  X  10 

$5,000.00 

200.00  X    9 

1,800.00 

Month  Equivalent 

6,800.00 

Average  Investment,  Af 

lonth  Equivalent 

$127,400.00 

B's  Investments: 

$15,000.00  X  12 

$180,000.00 

750.00  X    9 

6,750.00 

1,000.00  X    4 

4,000.00 

Month  Equivalent 

$190,750.00 

B's  Withdrawals: 

$500.00  X  II 

$5,500.00 

300.00  X  10 

3,000.00 

200.00  X    6 

1,200.00 

Month  Equivalent 

donth  Equivalent 

9,700.00 

,   Average  Investment,  '^ 

$181,050.00 

3IO 


ACCOUNTING  PRINCIPLES 


The  average  investment  of  each  partner  for  a  single  month 
having  thus  been  determined,  the  net  profits  are  divided  in  the 
ratio  of  127,400.00  to  181,050.00.  In  other  words,  ^'s  share 
will  be  $6,000.00x127,400/308,450,  or  $2,478.46;  while  5's 
share  will  be  $6,000.00  x  181,050/308,450,  or  $3,521.54. 

Another  method  of  calculating  the  average  investment  in- 
volves a  consideration  of  the  time  for  which  the  investment  re- 
mains unchanged,  thus: 


A 's  Investment 
$10,000.00 
11,000.00 
10,500  00 
10,300.00 
10,700.00 


Time  Unchanged    Month  Equivalent 


I  Month 
I  Month 
I  Month 
I  Month 
8  Months 


$10,000.00 
11,000.00 
10,500.00 
10,300.00 
85,600.00 


12  Months 

$127,400.00 

B's  Investment 

Time  Unchanged 

Month  Equivm 

$15,000.00 

I  Month 

$15,000.00 

14,500.00 

I  Month 

14,500.00 

14,200.00 

I  Month 

14,200.00 

14,950.00 

3  Months 

44,850.00 

14,750.00 

2  Months 

29.500.00 

15,750.00 

4  Months 

63,000.00 

12  Months  $181,050.00 

The  result  of  this  method  is  obviously  the  same  as  that  of 
the  preceding  one.  As  in  the  second  method,  however,  the 
sum  of  the  months  for  which  the  various  amounts  remain  im- 
changed  should  equal  the  number  of  months  for  which  the 
average  investment  is  computed,  a  safeguard  against  error  is 
provided  not  to  be  foimd  in  the  method  first  discussed. 

c.  Distribution  of  Profits  on  Basis  of  Capitals  at  End  of 
Period.  —  It  is  inadvisable  to  distribute  profits  on  the  basis  of 
the  investments  at  the  end  of  a  period,  unless  it  is  strictly  im- 
derstood  that  no  partner  can  add  to  his  capital  without  the 
consent  of  the  other  members  of  the  firm.  Otherwise,  a  part- 
ner can  affect  favorably  his  own  share  in  the  distribution  by  a 
large  addition  to  his  capital  toward  the  close  of  the  period. 


DISTRIBUTION  OF  THE  PARTNERSHIP  PROFITS     311 

The  basis  is,  in  fact,  not  commonly  used,  and  is  of  importance 
mainly  in  connection  with  liquidating  dividends. 

d.  Distribution  of  Profits  Partly  on  Basis  of  Capitals  at  Be- 
ginning of  Period  and  Partly  on  Basis  of  Agreed  Ratio.  —  It  is 
sometimes  stipulated  that  a  certain  percentage  on  capitals  shall 
be  paid  to  the  partners  before  the  balance  to  be  distributed  is 
divided  upon  an  agreed  ratio.  As  was  pointed  out  above,  this 
percentage  on  capitals  is  not  regarded  as  interest,  in  the  ordi- 
nary sense  of  the  term,  and  is  not,  therefore,  charged  to  the 
regular  interest  account.  Interest  on  partners'  capitals  is  the 
name  generally  given  to  the  account  covering  these  charges. 
While  the  accoimt  is  closed  into  profit  and  loss,  it  is  placed  in 
the  distribution  section,  along  with  interest  on  withdrawals. 
There  might  also  be  an  interest  credit  on  contributions  in  ex- 
cess of  the  capitals  at  the  beginning  of  the  period.  This  inter- 
est on  excess  capital  would  be  a  charge  against  net  profits  in 
the  distribution  section  of  the  profit  and  loss  account,  and  a 
credit  to  the  respective  capitals. 

There  are  several  forms  in  which  this  method  of  distribution 
may  be  made.  It  may  be  agreed,  for  instance,  that  interest  on 
partners'  capitals  shall  be  allowed  only  to  the  extent  to  which 
it  is  earned.  Unless  a  limitation  of  this  kind  is  set  up,  the  in- 
terest claims  may  create  a  deficit  in  the  balance  of  profit  and 
loss,  to  be  charged  to  the  capital  accounts  on  the  profit  and 
loss  sharing  ratio.  Again,  the  agreement  may  provide  that  half 
of  the  profits  or  losses  shall  go  to  the  partners  on  the  basis  of 
their  investments  at  the  beginning  of  the  period  or  on  the  basis 
of  their  average  investments  for  the  time,  the  other  half  to  be 
divided  according  to  fixed  proportions.  It  is,  therefore,  of  im- 
portance to  consider  the  various  possibilities,  and  to  let  the  ar- 
ticles of  partnership  definitely  express  the  wishes  of  the  mem- 
bers of  the  concern. 


QUESTIONS   AND   PROBLEMS 

I.  A  and  B  are  general  partners  without  an  agreement  as  to  the  division 
of  profits  and  losses.  A  has  a  capital  of  $10,000.00  and  B  a  capital  of  $12,- 
000.00.     They  have  profits  of  $5,000.00  and  decide  to  allow  5%  on  their 


312  ACCOUNTING  PRINCIPLES 

respective  capitals  before  division.    Journalize  the  distribution  of  profits 
and  set  up  a  ledger  record  of  it. 

2.  M,  N,  and  O  are  partners,  sharing  equally  in  the  profits,  but  with 
unequal  investments  on  which  interest  is  allowed  bef6re  the  remaining 
profits  are  distributed.  At  the  end  of  a  year  there  is  due  M  for  interest 
$250.00,  N  $125.00,  and  O  $225.00.  The  profits  for  the  year  before  interest 
charges  are  taken  into  account  are  $3,600.00.  (i)  Make  the  entries  to 
adjust  interest  and  profits,  using  the  nominal  accounts  of  interest  on 
partners'  investments  for  the  interest  charges. 

3.  A,  B,  and  C  are  partners  having  capitals  as  foUows:  A,  $10,000.00; 
B,  $15,000.00;  and  C,  $20,000.00.  A  has  loaned  $4,000.00  to  the  business 
at  6%;  B  has  loaned  $4,000.00  at  6%;  and  C  has  loaned  $6,000.00  at  6%. 
There  is  an  understanding  that  interest  will  be  allowed  on  capitals  at  5% 
and  that  the  balance  of  net  profits  will  be  divided  equally.  The  net  profits 
of  the  year  are  $1,500.00.  Give  the  journal  entries  involved  in  its  distri- 
bution. 


CHAPTER  XXIII 
LIQUIDATION   OF  A  SOLVENT  PARTNERSHIP 

1.  Sources  of  Partnership  Funds.  —  Where  the  partners 
themselves  have  furnished  all  the  funds  necessary  to  the  pur- 
chase of  the  assets  of  the  partnership,  the  distribution  of  the 
funds  arising  from  the  liquidation  of  the  business  is  not  a  com- 
plex problem.  The  assets  or  the  proceeds  of  their  sale  are  sim- 
ply distributed  to  the  partners  on  the  basis  of  their  capital 
balances  or  on  whatever  basis  may  be  stipulated  in  the  part- 
nership agreement.  There  are  usually,  however,  a  number  of 
outside  creditors,  some  of  whom  not  infrequently  hold  a  mort- 
gage against  specific  assets  to  secure  the  loan  of  money  or  the 
sale  of  goods  on  credit.  Furthermore,  the  wage  earners  at  the 
time  of  liquidation  may  not  have  been  paid  in  full,  and  thus 
have  a  preferential  claim  against  the  assets  of  the  business. 
Not  infrequently,  too,  the  partnership  is  indebted  to  the  indi- 
vidual partners  for  funds  advanced  by  them  in  addition  to  their 
capital  investments.  As  a  final  complication,  the  proceeds  of 
liquidation  may  be  distributed  at  intervals  rather  than  at  one 
time  after  all  the  assets  have  been  sold. 

2.  Causes  of  Liquidation.  —  A  partnership  may  be  liquidated 
for  one  or  more  of  the  following  reasons:  (a)  One  of  the  part- 
ners may  die,  in  which  case  the  estate  of  the  decedent  can  de- 
mand a  settlement  for  his  interest.  This  settlement  involves 
either  a  purchase  of  this  interest  by  one  of  the  surviving  part- 
ners or  by  an  outsider  whom  the  surviving  partners  are  willing 
to  take  into  the  firm,  or  a  sale  of  all  the  assets  and  a  distribu- 
tion of  the  proceeds,  (b)  The  obligations  to  outside  creditors 
may  not  be  paid  at  maturity,  and  liquidation  may  be  forced 
for  the  satisfaction  of  their  claims,  (c)  The  partners  may  vol- 
untarily agree  to  discontinue  the  business,  or  the  term  or  pur- 
pose for  which  the  partnership  was  established  may  be  fulfilled. 

313 


314  ACCOUNTING  PRINCIPLES 

{d)  One  of  the  partners  may  force  a  liquidation  for  the  satis- 
faction of  a  credit  claim  arising  out  of  a  loan  to  the  firm. 

The  accounting  problems  occasioned  by  the  taking  in  of  a 
new  partner  and  by  the  purchase  of  the  interest  of  a  retiring 
partner  have  already  been  discussed  in  a  preceding  chapter. 
We  shall  now  take  up  the  more  complicated  cases,  which  re- 
quire a  sale  of  all  the  assets  and  a  distribution  of  the  proceeds 
among  a  variety  of  claimants  on  the  basis  of  the  priority  of 
their  claims. 

3.  Liquidating  Dividends.  —  The  proceeds  of  liquidation  of 
a  partnership  are  apphed  (i)  to  the  payment  of  claims  of  out- 
side creditors,  (2)  to  the  payment  of  loans  by  the  partners  to 
the  business,  and  (3)  to  the  payment  of  the  partners'  capital 
investments.  Before  any  liquidating  dividends  can  be  made 
on  accoimt  of  the  partners'  capitals,  however,  the  losses  from 
liquidation  must  first  be  distributed  as  charges  to  the  partners' 
capital  accoimts  on  the  basis  of  the  profit  and  loss  sharing  ratio. 
These  losses  are,  of  course,  the  excess  of  the  book  value  of  the 
assets  over  the  price  at  which  they  are  sold.  For  example,  if 
land  and  buildings,  furniture  and  fixtures,  and  delivery  equip- 
ment are  carried  on  the  books  at  $25,000.00,  $5,000.00,  and 
$2,500.00,  and  are  sold  for  $20,000.00,  $4,000.00,  and  $2,- 
000.00,  resp)ectively,  the  losses  from  liquidation  are  $6,500.00. 
The  transaction  would,  therefore,  be  journalized  as  follows: 


Cash 

26,000 .  00 

Losses  from  Liquidation 

6,500.00 

T.and  and  Bviildings 

25,000.00 

Furniture  and  Fixtures 

5,oco.oo 

Delivery  Equipment 

2,500.00 

On  the  assimiption  that  A  and  B  are  partners  sharing  profits 
and  losses  equally,  the  foregoing  losses,  at  the  time  of  closing 
the  books,  would  be  charged  to  their  capital  accounts  in  equal 
amounts,  as  follows: 

A's  Capital  3,250.00 

B's  Capital  3,250.00 

Losses  from  Liquidation  6,500.00 


LIQUIDATION  OF  A  SOLVENT  PARTNERSfflP        315 

4.  Liquidating  Dividends  to  Creditors.  —  The  claims  of  out- 
side creditors  are  paid  in  the  order  of  their  priority.  If  there 
are  preferential  claims,  as  for  wages,  taxes,  court  costs,  etc., 
these  in  Texas  must  6rst  be  met  in  full.  Next  in  rank  are  the 
creditors  whose  claims  are  \^holly  or  partially  secured,  the  pro- 
ceeds arising  from  the  sale  of  the  mortgaged  or  hypothecated 
assets  being  first  applied  to  the  satisfaction  of  the  obligations 
they  were  pledged  to  secure.  If  there  is  a  surplus  over  the 
amount  required  to  meet  these  claims,  this  surplus  is  available 
to  meet  the  claims  of  unsecured  or  general  creditors.  If  there 
is  a  deficit,  the  deficiency  ranks  as  an  unsecured  or  general 
claim  against  the  free  assets  of  the  business.  Thus,  if  the  pro- 
ceeds of  liquidation  are  sufficient  to  pay  the  preferential  and 
secured  claims  and  in  addition  25  per  cen^  of  the  unsecured 
claims  of  general  creditors,  the  preferential  and  secured  credit- 
ors will  be  paid  in  full,  while  the  unsecured  or  general  creditors 
will  receive  a  liquidating  dividend  of  25  per  cent,  distributed 
ratably  on  the  basis  of  the  amounts  of  their  respective  claims. 

5.  Payment  of  Loans  from  Partners.  —  Loans  from  partners 
should  never  be  paid  until  losses  from  liquidation  have  been 
distributed,  for  it  may  well  happen  that  the  aggregate  of  the 
losses  chargeable  to  one  of  the  partners  may  exceed  his  capital 
investment.  If  his  loan  has  not  been  paid,  the  capital  defi- 
ciency may  be  charged  to  the  partner's  loan  account;  whereas, 
if  the  loan  has  been  paid  and  the  partner  becomes  insolvent, 
the  capital  deficiency  becomes  a  loss  to  the  other  partners. 
For  example,  suppose  that  A  and  B  have  capital  investments 
of  $5,000.00  and  $15,000.00,  respectively,  and  share  profits  and 
losses  equally.  Let  us  suppose,  further,  that  they  have  loaned 
the  business  $4,000.00  and  $6,000.00,  respectively.  In  the 
process  of  liquidation,  the  assets  are  sold  for  $14,000.00,  in- 
volving a  loss  of  $16,000.00.  yl's  portion  ($8,000.00)  would 
exceed  his  capital  investment  by  $3,000.00.  If  A  were  in- 
solvent and  his  loan  account  had  already  been  paid,  his  capital 
deficiency  would  become  an  additional  loss  to  B.  If  the  losses 
from  liquidation  had  been  charged  to  the  partners'  capital 
accounts  before  any  liquidating  dividend  had  been  made  on 


3l6  ACCOUNTING  PRINCIPLES 

account  of  the  partners'  loans,  the  capital  deficiency  could  have 
been  remedied  as  follows: 


A's  Capital 

S,ooo.oo 

^'sLoan 

3,000.00 

5's  Capital 

8,000.00 

Losses  from  Liquidation 

16,000.00 

The  $14,000.00  of  cash  received  for  all  the  assets  would  then 
be  distributed  as  follows: 

-4'sLoan  1,000.00 

.B's  Loan  6,000.00 

B's  Capital  7,000.00 

Cash  14,000.00 

With  these  journal  entries,  the  accounts  of  the  partnership 
would  be  closed  and  the  business  liquidated. 

6.  Problems  of  Liquidation  in  Periodical  Dividends.  —  When 
the  process  of  Uquidation  extends  over  a  long  period,  the  cred- 
itors may  desire  partial  payments  from  time  to  time  as  the  as- 
sets are  sold.  Where  this  plan  of  liquidation  is  adopted,  there 
will  ordinarily  be  expenses  of  liquidation.  These  expenses  may 
be  closed  into  the  account  of  Losses  from  Liquidation,  or  may 
be  charged  to  this  account  in  the  first  instance  if  the  transac- 
tions are  small  in  number.  Before  a  liquidating  dividend  is  de- 
clared, these  losses  and  expenses  are  charged  to  the  partners' 
capital  accounts  on  the  profit  and  loss  sharing  ratio. 

Let  us  suppose  that  A,  B,  and  C  are  partners  sharing  profits 
and  losses  equally.  On  December  31,  1919,  they  have  assets 
and  Uabilities  as  shown  on  the  following  page. 


LIQUIDATION  OF  A  SOLVENT  PARTNERSfflP  317 

A.  B.  C.  COMPANY 
Balance  Sheet,  December  31,  1919 

Assets  Liabilities 

Real  Estate  $25,000.00      Mortgage  on  Real  Es- 

Other  Assets            132,500.00          tate  $15,000.00 

Notes  Payable  (se- 
cured) 40,000.00 
Accounts  Payable  2  5 ,000 .  00 
^'sLoan  10,000.00 
5's  Loan  15,000.00 
C's  Loan  7,500.00 
^'s  Capital  15,000.00 
B's  Capital  20,000  00 
C's  Capital  1 0,000 .  00 
$157,500.00                             ■               $157,500.00 


Early  in  January,  1920,  it  is  decided  to  liquidate  the  business, 
and  during  the  month  the  following  sales  are  made: 

Cost  Sale  Price 

Real  Estate                                $25,000.00  $20,000.00 

Other  Assets                                30,000 . 00  22,000.00 

$55,000.00  $42,000.00 

The  expenses  of  liquidation  for  January  are  $2,000.00. 
The  foregoing  transactions  may  be  journalized  as  follows: 

Cash  42,000.00 

Losses  and  Expense  from  Liqui- 
dation 13,000.00 
Real  Estate  25,000.00 
Other  Assets                                                           30,000 .  00 

Losses  and  Expense  from  Liqui- 
dation 2,000.00 
Cash  2,000 .  00 

^'s  Capital  5,000.00 

B's  Capital  5,000.00 

C's  Capital  5,000.00 

Losses    and    Expense    from 

Liquidation  15,000.00 


3l8  ACCOUNTING  PRINCIPLES 

From  the  balance  of  cash  ($40,000.00),  it  is  possible  to  pay  the 
mortgage  in  full  and  $25,000.00  on  the  notes  payable,  which  are 
secured.    The  distribution  would  be  journalized  as  follows: 

Mortgage  on  Real  Estate  15,000.00 

Notes  Payable  (secured)  25,000.00 

Cash  40,000 .  00 

A  statement  of  the  transactions  for  the  month  would  involve 
a  summary  statement  of  the  January  liquidations  together  with 
a  balance  sheet  showing  the  conditions  of  the  business  after 
these  hquidations  had  taken  place.  The  summary  of  liquida- 
tion might  be  made  as  follows:  ,  •     j  .• 

Sale  Price  Losses 

Cash  Received  during  Month: 
Sale  of  Real  Estate  •  $20,000.00       $5,000.00 

Sale  of  Other  Assets  22,000.00         8,000.00 

Total  Cash  Received  42,000 .  00 

Expenses  of  Liquidation  2.000.00         2,000.00 

Balance  of  Cash  40,000.00 

Cash  Distribution: 
Mortgage  on  Real  Estate  15,000.00 
Notes  Payable  25000.00         40,000.00 

Total  Losses  in  Liquidation  15,000.00 

Losses  Charged  as  Follows: 
-i4's  Capital  5,000.00 

B's  Capital  5,000.00 

Cs  Capital  5,000.00  15,000.00 

A.  B.  C.  COMPANY 
Balance  Sheet,  January  31,  1920 

Assets  LiabilUies 

Other  Assets         $102,500.00      Notes    Payable    (se- 

oired)  $15,000.00 

Accounts  Payable  25,000.00 

A's  Loan  10,000.00 

5's  Loan  15,000.00 

Cs  Loan  7,500.00 

A's  Capital  10,000.00 

B's  Capital  15,000.00 

Cs  Capital  5,000.00 
$102,500.00                                            $102,500.00 


LIQUIDATION  OF  A  SOLVENT  PARTNERSHIP         319 

During  the  month  of  February,  the  remaining  assets  are 
sold  for  $70,000.00  at  an  expense  of  $3,500.00.  The  journal 
entries  recording  the  sale  and  distribution  of  the  hquidation 
losses  would  be  as  follows: 


Cash 

70,000 .  00 

Losses  from  Liquidation 

32,500.00 

Other  Assets 

102,500.00 

Losses  and  Expense  from  Liquidation 

3,500.00 

Cash 

3,500.00 

.4's  Capital 

10,000 .  00 

.4's  Loan 

2,000.00 

B's  Capital 

12,000.00 

C's  Capital 

5,000.00 

C's  Loan 

7,000.00 

Losses  and  Expense  from  Liquidation  36,000 .  00 

The  cash  balance  of  $66,500.00  would  then  be  distributed 
by  means  of  the  following  entry: 


Notes  Payable  (seciu"ed) 

15,000.00 

Accoimts  Payable 

25,000.00 

.4's  Loan 

8,000.00 

B's  Loan 

15,000.00 

C's  Loan 

500.00 

B's  Capital 

3,000.00 

Cash 

66,500.00 

A  summary  of  the  liquidation  operations  should  again  be  made 
for  the  month  of  January,  though  this  time  there  would  be  no 
balance  sheet,  inasmuch  as  all  the  assets  have  been  sold  and 
all  the  Uabilities  liquidated. 

Let  us  now  suppose  that  at  the  end  of  January  the  balanee 
of  each  of  the  capital  accounts  was  in  excess  of  the  chargeable 
losses,  and  that  at  the  same  time  funds  were  available  to  pay 
in  full  the  claims  of  outside  creditors  and  50  per  cent  of  the 
partners'  loan  accounts.  The  question  then  arises  as  to  whether 
there  should  be  a  ratable  distribution  to  the  partners  according 
to  their  loan  account  balances.  Such  a  course  would  be  proper 
were  it  not  for  the  fact  that  one  cannot  foresee  how  great 


320  ACCOUNTING  PRINaPLES 

future  losses  from  liquidation  may  be.  A  future  loss  chargeable 
to  one  of  the  partners  may  well  exceed  the  balance  of  his  capi- 
tal account  and  the  remaining  50  per  cent  of  his  loan  account. 
If  this  should  happen  in  the  case  of  an  insolvent  partner,  it 
would  vitiate  the  distribution  of  losses  on  the  profit  and  loss 
sharing  ratio  and  result  in  the  final  charge  of  the  insolvent" 
partner's  share  to  his  solvent  copartners.  To  avoid  such  an 
occurrence,  it  is  sometimes  urged  that  any  periodic  dividend  on 
loans  to  partners  should  be  made  so  as  to  reduce  the  loan  bal- 
ances to  the  profit  and  loss  sharing  ratio.  Such  a  procedure 
will  not,  however,  insure  the  final  apportionment  of  losses  on 
the  profit  and  loss  sharing  ratio,  unless  the  balance  of  the  capi- 
tal accounts  are  brought  to  the  same  ratio;  for,  where  the  capi- 
tal balances  are  not  in  the  profit  and  loss  sharing  ratio,  a  loss 
chargeable  to  one  of  the  p)artners  may  at  a  subsequent  date 
exceed  his  capital  balance  and  fall  on  his  loan,  thus  disturbing 
the  profit  and  loss  sharing  ratio  which  had  been  set  up. 

There  are,  however,  possibilities  of  a  periodic  settlement  in- 
volving loans  and  capitals  without  endangering  the  distribu- 
tion of  losses  on  the  profit  and  loss  sharing  ratio.  If  Uquidation 
has  at  any  time  proceeded  to  the  point  where  the  cash  balance 
exceeds  the  loans  from  partners  by  an  amount  suflScient  to  re- 
duce the  capitals  to  the  profit  and  loss  sharing  ratio,  a  distribu- 
tion that  will  retire  the  partners'  loans  and  reduce  the  capitals 
to  the  profit  and  loss  sharing  ratio  may  safely  be  made. 

The  prior  claim  for  distribution  of  losses  on  the  profit  and 
loss  sharing  ratio  destroys  the  priority  of  partners'  loans  over 
their  capital  in  the  case  of  the  liquidation  of  a  solvent  partner- 
ship. If  the  rule  for  charging  losses  on  the  profit  and  loss  shar- 
ing ratio  is  held  to  be  binding  so  that  losses  can  be  charged 
against  partners'  loans  instead  of  their  capital  when  the  losses 
for  any  partner  exceed  loans,  then  no  valuable  right  is  sacri- 
ficed by  the  partners  if  they  add  their  loans  to  their  capitals 
for  purposes  of  liquidation  and  create  an  account  of  loan  and 
capital  for  each  partner  which  represents  his  personal  claim 
against  the  assets.  Distribution  of  liquidating  dividends  should 
then  be  made  so  that  the  totals  of  the  partnership  claims  of  the 


LIQUIDATION  OF  A  SOLVENT  PARTNERSHIP         321 

several  partners  will  be  reduced  to  the  profit  and  loss  sharing 
ratio. 

For  illustration  let  us  suppose  that  A ,  B,  and  C  are  partners 
with  the  following  balance  sheet: 


Sundry  Assets   .      .    $85,500.00 


Notes  Payable    . 
Accounts  Payable 
^'s  Loans 
B's  Loans 
C's  Loans 
A's  Capital 
B's  Capital 
C's  Capital 


$85,500.00 


$10,000.00 

15,000.00 

7,500.00 

4,000.00 

6,000.00 

10,000.00 

15,000.00 

18,000.00 

$85,500.00 


Let  us  now  suppose  that  assets  are  sold  in  January  for  $44,- 
000.00  that  cost  $65,000.00.  Of  this  amount  $25,000.00  would 
be  used  to  pay  the  notes  and  accounts  payable,  journal  entries 
being  made  as  indicated  in  paragraph  6,  leaving  $19,000.00  to 
be  used  as  a  liquidating  dividend.  Since  the  losses  reduced  the 
total  claims  of  partners  to  $39,500.00,  the  $19,000.00  dividend 
would  reduce  the  balance  of  these  claims  to  $20,500.00.  The 
$19,000.00  must  be  so  distributed  that  the  balance  of  each 
claim^would  be  equal  or  in  the  profit  and  loss  sharing  ratio,  or 
$6,833.33.  Subtracting  the  desired  balance  from  each  of  the 
partners'  balances  after  liquidating  losses  are  charged  would 
give  their  respective  shares  in  the  distribution  as  shown  in  the 
table  below. 

If  we  now  suppose  the  $20,500.00  balance  of  assets  to  be  sold 
in  February  for  $8,500.00,  the  $12,000.00  of  loss  would  be  first 
charged  to  the  partner  claims  equally.  The  balance  of  $8,- 
500.00  cash  would  then  be  distributed  equally  to  the  partners 
as  shown  in  the  table  on  the  following  page. 


322  ACCOUNTING  PRINCIPLES 


Loan 

Capital  .... 

Total  .... 
Liqmdating  Losses 

Balance 
Liqiiidating  dividends 

Balance    . 
Liquidating  Losses 

Balance    . 
Liquidating  dividends 


ABC       Total  dcims 

of  partners 

$  7,500.00$  4,000.00$  6,000. 00 $17. 500. 00 

10.000.00    1 5.000.0c    iS.000.00   43,000.00 


$17, 500. 00 $19.000. 00 $24,000. 00  560.500.00 
7,000.00      7,000.00     7.000.00    21.000.00 


$10,500 .  00  $1 2,000 .  00  $1 7.000 .  00  $39,500 .  00 
3,666.66     5,166.67    10,166.67    19,000.00 


$6,833.34   $6,833.33   $6.833.33 $20,500.00 
4,000.00     4,000.00     4,000.00    12,000.00 


$2,833.34   $2,833.33   $2,833.33   $8,500.00 
2,833.34     2,833.33      2.833.33     8,500.00 


If  the  loan  and  capital  claims  had  not  been  consolidated  it 
would  not  have  been  safe  to  have  distributed  the  $19,000.00 
liquidating  dividend  in  Januarv'  because  future  losses  might 
more  than  cover  the  capitals  of  some  of  the  partners.  The 
$19,000.00  would  have  paid  all  partners'  loans  and  left  $1,500.00 
for  a  dividend  on  capitals.  This  dividend,  however,  would  not 
have  sufl5ced  to  have  reduced  the  balance  of  capitals  to  an 
equality.  The  January  losses  would  have  reduced  yl's  capital 
to  $3,000.00  and  C  would  have  been  entitled  to  the  $1,500.00 
dividend  if  it  had  been  distributed.  The  February  loss  of 
$4,000.00  would  have  more  than  wiped  out  ,4's  capital.  Since 
the  loan  would  have  been  paid  B  and  C  might  not  have  been 
able  to  collect  from  A  his  share  of  the  losses  unless  he  were 
personally  solvent.  It  would  have,  therefore,  been  improper 
to  allow  the  January  distribution.  By  the  consohdation  of  the 
capital  and  loan  interests  the  partners  both  protect  their  right 
and  secure  liquidating  dividends  at  an  earUer  date. 

7.  Reduction  of  the  Capitals  to  the  Profit  and  Loss  Sharing 
Ratio.  —  Pro  rata  liquidating  dividends  on  capitals  render  dif- 
ficult the  distribution  of  losses  on  the  profit  and  loss  sharing 
ratio  imless  the  capitals  are  themselves  reduced  to  this  particu- 
lar ratio.  Where  there  are  periodic  liquidating  dividends  on 
capitals,  therefore,  it  is  generaUy  urged  that  the  first  dividend 
should  be  distributed  so  as  to  reduce  the  capitals  to  the  profit 
and  loss  sharing  ratio  in  so  far  as  this  may  be  possible.    For 


LIQUIDATION  OF  A  SOLVENT  PARTNERSHIP         323 

example,  let  us  suppose  that  A  and  B  are  partners,  with  capi- 
tals of  $25,000.00  and  $35,000.00,  respectively,  and  that  they 
share  profits  and  losses  equally.  Let  us  suppose,  further,  that 
they  dispose  of  assets  with  a  book  value  of  $30,000.00  for 
$20,000.00,  the  proceeds  to  be  applied  first  to  the  liquidation 
of  accounts  payable  amounting  to  $10,000.00.  To  record  the 
transactions,  the  following  journal  entries  would  be  made : 


Cash 

20,000.00 

Losses  from  Liquidation 

10,000.00 

Sundry  Assets 

$30,000.00 

A's  Ccpital 

5,000.00 

B's  Capital 

5,000.00 

Losses  from  Liquidation 

10,000.00 

Accounts  Payable 

10,000.00 

Cash 

10,000.00 

By  these  entries  the  total  capital  has  been  reduced  to  $50,- 
000.00,  while  the  total  cash  has  been  reduced  to  $10,000.00. 
The  distribution  of  this  cash  balance  to  the  partners  will  reduce 
the  total  capital  to  the  still  lower  figure  of  $40,000.00.  The 
distribution  should  be  made,  however,  so  as  to  bring  the  capi- 
tal balances  to  the  profit  and  loss  sharing  ratio.  Since  ^'s 
capital  is  $20,000.00,  the  remaining  cash  available  for  distribu- 
tion must  be  applied  to  the  reduction  of  5's  capital  to  the 
same  amount.    This  is  effected  by  the  following  journal  entry: 

B's  Capital  10,000.00 

Cash  10,  00.00 

By  these  entries,  the  liquidated  assets  have  been  fully  distrib- 
uted and  the  capital  balances  so  adjusted  that  future  liquidat- 
ing dividends  can  be  made  on  a  pro  rata  basis  without  pre- 
venting a  distribution  of  losses  on  the  profit  and  loss  sharing 
ratio,  the  two  ratios  being  now  one  and  the  same. 

8.  Overdraft  of  CapitaL  —  At  any  time  that  the  losses  in 
liquidation  apportioned  to  a  given  partner  exceed  his  loan,  the 
amount  of  such  overdraft  is  charged  against  his  loan  to  the 
business  if  any.  If  there  were  no  loan,  or  the  overdraft  ex- 
ceeded the  loan,  the  amount  of  the  overdraft  would  be  charged 


324 


ACCOUNTING  PRINCIPLES 


to  his  personal  account  if  he  were  solvent,  and  to  the  other 
partners  in  accordance  with  their  profit  and  loss  sharing  ratio, 
if  he  were  insolvent.  When  the  capital  and  loans  are  com- 
bined for  the  purpose  of  liquidation,  the  loss  apportioned  to  a 
particular  partner  might  exceed  the  total  of  his  interest,  in 
which  case  the  amount  would  be  charged  against  his  personal 
account  if  he  were  solvent  and  to  the  other  partners  if  he  were 
insolvent. 

For  example,  suppose  A,  B,  and  C  are  equal  partners  with 
capitals  of  $2,000.00,  $3,000.00,  and  $5,000.00  respectively  and 
loans  of  $4,000.00,  $2,000.00,  and  $3,000.00.  The  liabilities  are 
$25,000.00.  Suppose  the  losses  in  liquidation  are  $18,000.00; 
that  is,  the  assets  are  sold  for  $26,000.00.  The  following  jour- 
nal entry  would  show  the  facts: 


Cash 

Losses  in  Liquidation 
Sundry  Assets    . 

A 's  Interest 
B's  Interest 
C's  Interest 
Losses  in  Liquidation 


26,000 .  00 
18,000.00 


44,000.00 


6,000.00 
6,000.00 
6,000.00 


18,000.00 


But  the  total  interests  of  the  partners  would  be  as  follows: 

ABC  Total 

Loan  ....  4,000.00  2,000.00  3.000.00  9,000.00 
Capital  ....  2,000.00  3,000.00  5,000.00  10,000.00 
Total  Interest   .  6,000.00     5,000.00     8,000.00   19,000.00 

I 

Since  the  total  of  B's  interest  is  $1,000.00  less  than  the  loss 

chargeable  to  him,  it  will  be  necessary  to  increase  his  interest 
bj  the  following  entry: 


Cash     .     . 
5's  Interest 


1,000.00 


1,000.00 


This  entry  is  made  in  case  he  is  solvent  and  can  furnish  funds 
to  meet  the  claim  against  him.  The  total  interests  would  then 
be  as  follows: 


LIQUIDATION  OF  A  SOLVENT  PARTNERSHIP         325 

ABC  Total 

Total  Interest   .     .       6,000.00     5,000.00     8,000.00   19,000.00 
Added  Interest  of  B  1,000.00  1,000.00 


Total  Interest   .      .       6,000.00     6,000.00     8,000.00   20,000.00 

Losses  in  Liquidation    6,000.00     6,000.00     6,000.00   18,000.00 

0.00  0.00     2,000.00     2,000.00 

The  total  cash  will  now  be  $27,000.00.  The  first  distribution 
would  be  journalized  as  follows: 

1.  Liabilities  25,000.00 

Cash  25,000.00 

2.  Cs  Interest  2,000.00 

Cash  2,000.00 

These  two  entries  put  into  the  table  would  show  the  closing 

out  of  the  interests  as  follows: 

A  B  C 

Total  Interests        .      .     $ $ 2,000.00 

Liquidating  Dividends       2,000.00 

Of  course  the  last  entry  in  the  table  belongs  with  the  other 
items.    It  was  separated  for  the  purpose  of  analysis. 

In  the  illustrations  above  the  table  is  simply  an  abbreviated 
substitution  for  ledger  accounts.  In  case  the  student  under- 
stands the  procedure  better  when  the  accounts  are  employed 
he  may  substitute  these  for  the  table.  The  table  is  a  report 
form  and  not  the  ledger  form  of  entering  the  data.  It  was  used 
for  brevity  in  the  illustration  on  the  assumption  that  the  stu- 
dent would  at  the  same  time  readily  visualize  the  accounts  to 
be  set  up  in  the  ledger. 

9.  Justice  of  Distributing  Liquidation  Losses  on  the  Profit 
and  Loss  Sharing  Ratio.  —  The  question  may  fairly  be  raised 
as  to  whether  liquidation  losses  should  be  placed  on  the  same 
basis  as  operating  expenses  and  losses.  It  might  be  urged  that 
since  the  capital  balances  represent  the  ownership  interest  of 
the  partners  in  the  assets,  the  losses  from  liquidation,  which 
are  essentially  losses  in  these  assets,  should  be  borne  on  the 
basis  of  the  relative  ownership  claims.  While  this  view  would 
have  materially  simplified  the  problems  of  liquidation,  and 


326  ACCOUNTING  PRINCIPLES 

might  have  been  more  equitable  than  the  view  aheady  set 
forth,  it  is  not  the  view  adopted  by  the  common  law.  The 
profit  and  loss  sharing  ratio  has  been  the  dominant  principle  in 
the  liquidation  of  partners'  claims  against  the  assets  of  the 
partnership,  pro  rata  distribution  on  partners'  loans  and  part- 
ners' capitals  being  made  only  to  the  extent  to  which  this  type 
of  distribution  does  not  prevent  the  charging  of  Uquidation 
losses  on  the  profit  and  loss  sharing  basis. 

PROBLEMS  AND  QUESTIONS 

1.  To  what  accounts  are  losses  in  liquidation  charged? 

2.  Can  you  l^ally  declare  a  liquidating  diWdend  on  capitals  before 
paying  all  liabilities? 

3.  WTiat  is  the  order  of  priority  among  the  liabilities? 

4.  \Miy  is  it  impossible  to  give  the  loans  from  partners  the  priority 
over  their  capital  claims  to  which  the  obligation  is  apparently  entitled? 

5.  Is  it  possible  to  enforce  the  rule  of  charging  losses  in  liquidation 
on  the  profit  and  loss  sharing  ratio,  making  the  partners'  loans  chargeable 
for  a  deficit  in  capital,  and  at  the  same  time  give  priority  to  the  loans  over 
the  capital  of  the  partners? 

6.  If  the  partners'  loans  are  combined  with  their  capitals  for  the  purpose 
of  liquidation,  do  the  shares  received  by  the  partners  differ  in  total  from 
what  the  partners  would  receive  if  the  loans  and  capitals  were  kept  sep>arate 
and  at  the  same  time  liquidation  were  carried  forward  so  that  all  losses 
would  be  chargeable  to  the  partners'  capital  or  to  their  loans  in  case  of  a 
capital  deficit?    Exj)lain  your  answer  fully. 

7.  A,  6,  and  C  are  equal  partners  with  capitals  and  loans  as  foUows: 

ABC 
Loans       ....      $6,000.00         $7,500.00       $10,000.00 
Capitals  ....       12,500.00         15,000.00         20,000.00 

The  p>artnership  owes  $10,000.00  to  fully  secured  creditors  and  $15,000.00 
to  unsecured  creditors.  Partner  .\  b  made  the  liquidator  and  is  allowed  5 
per  cent  of  the  proceeds  of  Uquidation  with  the  understanding  that  he  is  to 
be  paid  this  commission  by  the  other  two  partners.  (In  such  cases  the 
settlement  is  a  private  settlement  and  is  not  entered  on  the  books.) 

In  the  month  of  Januar>'  assets  costing  $45,000.00  were  liquidated  at 
$30,000.00  cash.  Make  the  propwr  distribution  and  the  propjer  charges  for 
Januarj-. 

In  February  the  balance  of  assets  are  sold  at  50  cents  on  the  dollar. 
Make  the  entries  involved  in  winding  up  the  partnership  in  February. 

8.  (a)  X,  Y,  and  Z  are  equal  partners  with  the  following  interests: 

X  ¥■  Z 

Loans       ....      $2,000.00         $4,000.00         $6,000.00 
Capital    ....        6,000.00  8,000.00         10,000.00 


LIQUIDATION  OF  A  SOLVENT  PARTNERSHIP         327 

They  owe  outside  creditors  $3o,(xio.cx3.  They  sell  the  total  assets  for  50 
per  cent  of  their  book  value.  X  is  solvent  and  can  therefore  be  charged  with 
any  deficit  for  which  his  interest  does  not  provide.  Make  entries  to  wind 
up  the  partnership. 

(b)   Solve  the  same  problem  on  the  assumption  that  X  is  insolvent 
and  could  not  meet  any  deficit  in  his  interest. 


CHAPTER   XXrV 
CORPORATE   ORGANIZATION  AND   ACCOUNTING 

1.  The  Original  Proprietary  Interest.  —  It  has  been  set  forth 
in  preceding  chapters  that  in  the  corporation  the  proprietary 
interest  instead  of  being  expressed  in  the  dollar  unit  only,  as 
in  the  partnership  and  individual  business,  is  expressed  in 
terms  of  share  units  of  so  many  dollars  per  share.  A  stock- 
holder will  say  that  he  owns  ten  shares  of  stock  in  the  corpora- 
tion, each  share  having  a  certain  par  or  face  value,  such  as 
$100.00  or  $150.00.  This  original  par  value  is  intended  by  the 
various  states  which  have  authorized  the  organization  of  cor- 
porations to  represent  the  number  of  dollars  invested  by  the 
shareholder  for  each  share  owned.  It  does  represent  facts  of 
this  sort  in  some  cases.  But  property  is  frequently  transferred 
to  the  corporation  for  shares  of  stock  and  the  states  have  not 
in  many  cases  created  efficient  administrative  machinery  for 
carrying  out  the  intent  of  the  law.  Hence  the  face  value  of 
the  shares  frequently  does  not  signify  even  approximately  the 
actual  investment  of  the  shareholder  in  the  corporate  assets. 
The  journal  entry,  however,  is  generally  made  to  give  a  "book 
value"  to  assets  exchanged  for  corporate  shares  equal  to  the 
face  value  of  the  shares  so  issued.  That  is,  the  assets  are  gen- 
erally entered  as  having  a  money  value  equal  to  the  par  value 
or  face  value  of  the  shares  for  which  they  are  exchanged. 

2.  Shares  without  Par  Value.  —  Since  it  has  been  found 
that  the  par  or  face  value  of  shares  is  so  often  in  excess  of  the 
sale  value  of  the  assets  which  have  been  exchanged  for  the 
shares,  the  original  proprietary  interest  has  been  represented  in 
some  cases  by  shares  without  par  value.  If  these  shares  were 
sold  for  cash  by  the  corporation,  the  shareholders'  capital 
would  be  credited  for  the  amount  paid  instead  of  the  nominal 
value  appearing  on  the  face  of  the  shares.    Another  advantage 

328 


CORPORATE  ORGANIZATION  AND  ACCOUNTING     329 

to  be  realized  by  the  use  of  shares  without  par  value  is  found 
in  the  escape  from  the  statutes  requiring  that  the  money  or 
property  exchanged  for  shares  of  a  corporation  shall  be  at 
least  equal  in  value  to  the  par  of  the  shares  issued.  When  the 
shares  have  no  par  value  it  is  clear  that  the  shares  may  be  ex- 
changed for  such  money  or  property  as  the  corporation  may 
see  fit  to  accept  in  exchange.  The  credit  to  capital  and  to  the 
shareholders  would  be  determined,  however,  by  the  valuation 
placed  on  the  property  exchanged  for  such  shares. 

3.  Surplus.  —  The  earnings  of  a  corporation  may  be  dis- 
tributed to  the  stockholders  or  they  may  be  accumulated  into 
what  is  called  a  surplus  reserve.  When  earnings  are  distrib- 
uted they  are  always  distributed  pro  rata;  a  dividend  of  a  cer- 
tain number  of  dollars  for  each  share  is  declared  from  surplus 
and  distributed  on  a  certain  date  to  the  stockholders  of  record 
for  the  date  in  question.  The  profit  and  loss  account  is  closed 
into  a  surplus  account  instead  of  being  closed  into  a  capital 
account  as  would  be  the  case  for  the  partnership  or  the  indi- 
vidual business.  Extraordinary  profits  or  adjustments  in  the 
book  value  of  assets  are  carried  directly  through  the  surplus 
instead  of  through  profits  and  loss.  The  practice  of  the  corpo- 
ration in  this  respect  is  the  same  as  that  found  to  prevail  for 
the  partnership  and  the  individual  business. 

4.  Liabilities  of  the  Stockholders.  —  The  ordinary  private 
corporation  is  liable  to  its  creditors,  who  have  a  first  claim 
against  the  total  assets  of  the  corporation.  In  case  of  insol- 
vency, the  proceeds  of  the  sale  of  assets  would  be  subject  first 
to  the  claims  of  creditors.  Any  balance  remaining  after  all 
cieditors  are  fully  paid  is  distributed  pro  rata  to  the  sharehold- 
ers, but  the  shareholders  are  not  liable  for  the  debts  of  the 
corporation  except  to  the  extent  of  their  ownership  interest  in 
the  corporation.  If  the  corporation  itself  cannot  pay  its  lia- 
bilities out  of  the  assets  turned  over  to  it  in  exchange  for  the 
shares  of  the  stockholders,  the  creditors  have  no  other  remedy, 
and  must  accept  in  settlement  of  their  claim  a  pro  rata  dis- 
tribution of  the  proceeds  of  liquidation  of  such  assets  as  the 
corporation  may  own.     In  the  case  of  the  national  banks 


33©  ACCOUNTING  PRINCIPLES 

the  stockholders  are  liable  for  an  additional  levy  equal  to  the 
par  value  of  the  shares  which  they  may  hold,  in  case  this 
amount  is  required  to  pay  the  outstanding  liabilities  of  a 
bank.  The  immunity  of  the  shareholders  in  the  ordinary 
private  corporation  from  additional  levy  to  meet  the  liabilities 
of  the  corporation  in  case  of  insolvency  is  one  of  the  chief  char- 
acteristics of  the  corporation  commonly  relied  upon  to  popu- 
larize subscriptions  for  corporate  shares.  Large  amounts  of 
money  can  be  raised  more  readily  by  the  corporation  than  by 
the  partnership  on  this  account. 

5.  Classes  of  Stock.  —  The  corporation  may  have  only  one 
class  of  stock  or  it  may  have  several  classes.  The  most  com- 
mon types  of  capital  stock  are  common  and  preferred  stocks. 
There  are,  however,  several  varieties  of  preferred  shares,  such 
as  the  ordinary  preferred  and  the  cumulative  preferred.  In 
the  case  of  any  t}pe  of  preferred  there  may  be  a  first  preferred, 
a  second  preferred,  etc.  When  there  is  only  one  class  of  stock, 
no  stockholder  has  a  claim  which  is  to  be  preferred  over  that 
of  any  other  stockholder.  The  preferred  stockholders,  how- 
ever, ordinarily  have  a  claim  which  is  preferred  to  that  of  the 
common  stockholder  in  the  distribution  of  profits  and  in  the 
distribution  of  the  proceeds  of  the  liquidation  of  assets.  The 
provision  under  which  the  preferred  stock  is  issued  might  set  up, 
for  example,  the  right  to  a  dividend  of  7  per  cent  on  the  par 
value  of  the  shares  from  the  earnings  of  any  }'ear,  before  the 
common  stockholders  would  have  any  right  to  participate  in 
the  profits  of  the  year  in  question.  If  the  earnings  were  suffi- 
cient to  pay  the  7  per  cent  on  the  preferred  stock  and  a  divi- 
dend on  the  common  stock  in  addition,  the  common  sharehold- 
ers might  participate  in  the  distribution  of  profits.  Similarly, 
if  the  assets  of  the  corporation  are  sold,  the  balance  of  the 
proceeds  of  the  sale  of  the  assets  after  paying  the  liabilities  of 
the  corporation  would  be  available  for  distribution  to  the  hold- 
ers of  preferred  stock  in  an  amount  equal  to  the  par  value  of 
such  stock  outstanding.  The  balance  of  the  proceeds  of  liqui- 
dation in  excess  of  the  par  value  of  the  outstanding  preferred 
stock  would  then  be  available  for  distribution  to  the  holders  of 


CORPORATE  ORGANIZATION  AND   ACCOUNTING      33 1 

common  stock  or  to  the  holders  of  the  second  preferred  shares 
in  case  such  a  class  of  shares  existed.  There  is  some  variety  in 
the  rights  of  the  holders  of  preferred  stock.  They  might  have 
a  preference  over  the  common  stock  only  as  to  dividends,  with- 
out preference  as  to  assets.  The  holder  of  cumulative  preferred 
stock  would  have  the  same  rights  as  the  holder  of  the  pre- 
ferred stock  to  the  dividend  distribution  guaranteed  as  a  prior 
claim  over  distribution  to  the  holders  of  common  stock,  but 
the  dividend  of  any  particular  year  if  unpaid  would  accumulate 
in  succeeding  years  as  a  claim  of  the  preferred  shareholder 
which  must  be  met  prior  to  the  distribution  of  any  dividends 
to  the  holders  of  common  stock.  If  the  cumulative  preferred 
dividends  were  6  per  cent  and  the  corporation  should  be  un- 
able to  pay  this  dividend  in  the  first  and  second  years  of  its 
operation,  the  cumulative  claim  of  the  cumulative  preferred 
stockholders  would  be  18  per  cent  for  the  third  year  of  the 
operation  of  the  business.  The  corporation  is,  however,  under 
obligation  to  pay  the  dividend  to  preferred  stockholders  only 
when  the  dividend  is  earned.  It  does  not  become  a  liability  of 
the  corporation  in  the  sense  that  notes  payable  and  accounts 
payable  are  liabilities.  If  the  student  desires  to  make  a 
thorough  study  of  the  varieties  of  corporation  stock  issued 
against  the  corporate  property,  he  is  referred  to  the  texts  on 
corporation  finance  which  are  primarily  concerned  with  such 
matters.  The  preferred  stocks  themselves  may  be  classed  as 
follows:  (a)  preferred  stock,  second  preferred,  etc.;  (b)  cumu- 
lative preferred,  second  cumulative  preferred,  etc.  The  two 
types  (a)  and  (b)  may  exist  in  the  case  of  the  same  corpora- 
tion. Moreover,  either  class  (a)  or  class  (b)  may  be  preferred 
as  to  dividends  without  being  preferred  as  to  assets  or  vice 
versa.  Either  class  may  have  the  right  to  vote  or  it  may 
not.  Preferred  shares  may,  in  some  cases,  be  allowed  to  share 
with  the  common  stock  additional  dividends  after  their  pre- 
ferred claim  has  been  met  and  the  common  shareholders  have 
received  certain  specified  distributions. 

6.  Bonds.  —  The  corporation  employs  another  device  for 
raising  funds  to  carry  on  its  operations  through  the  sale  of 


332  ACCOUNTING  PRINCIPLES 

corporate  bonds.  These  bonds  may  be  debenture  bonds  or 
mortgage  bonds.  The  debenture  bonds  are  unsecured  notes 
maturing  in  a  certain  number  of  years  and  bearing  a  desig- 
nated rate  of  interest  on  the  par  value  of  the  bonds.  First 
mortgage  bonds  are  based  upon  a  first  mortgage  against  cer- 
tain designated  assets  which  must  be  sold  to  meet  the  claims 
of  such  bondholders  for  interest  or  principal  on  the  corporate 
debt  in  case  the  corporation  is  not  able  to  pay  such  obligations 
from  the  income  derived  from  its  operations.  The  amount  of 
the  bonds  issued  may  be  limited  to  50  per  cent  or  75  j)er  cent, 
or  to  some  designated  fraction  of  the  value  of  the  mortgaged 
property.  The  instrument  under  which  the  bonds  are  issued 
which  describes  the  rights  of  the  holders  of  the  bonds  and  of 
the  corporation,  is  called  a  "deed  of  trust."  This  deed  of 
trust  will  ordinarily  require  the  corporation  to  maintain  the 
mortgaged  property  and  carry  out  other  provisions  designed  to 
protect  the  interests  of  the  bondholders.  The  bonds  are  com- 
monly issued  in  denominations  of  Sioo.oo,  S500.00,  $1000.00, 
$5000.00,  or  in  amounts  representing  some  multiple  of  $100.00. 
The  face  value  of  the  bonds  will  be  the  amoimt  which  the  cor- 
jwration  promises  to  pay  the  bondholder  on  the  date  of  ma- 
turity of  the  bonds.  If  the  corporation  becomes  insolvent  at 
any  time  the  proceeds  of  the  sale  of  the  mortgaged  property 
must  be  devoted  first  to  the  pavmient  of  the  bonds  issued  on 
the  basis  of  the  mortgage.  Any  balance  which  might  remain 
would  be  available  to  meet  the  claims  of  general  creditors, 
such  as  those  represented  by  the  debenture  bonds  or  ordinary 
notes  and  accounts  of  the  corporation.  There  may  also  be  a 
second  mortgage  bond,  which  would  be  entitled  to  the  balance 
of  the  proceeds  of  the  liquidation  or  sale  of  mortgaged  prop>- 
erty  after  the  liabilities  to  the  first  mortgage  bondholders  had 
been  fully  met.  If  a  second  mortgage  exists,  the  general  cred- 
itors have  no  claim  against  the  proceeds  of  the  liquidation  of 
the  mortgaged  property  until  the  holders  of  the  second  mort- 
gage bonds  as  well  as  those  of  the  first  mortgage  bonds  have 
been  fully  paid.  Another  tN-pe  of  bonds  which  is  important  in 
accoimting  procedure  is  the  sinking  fund  bond.    The  deed  of 


CORPORATE  ORGANIZATION  AND  ACCOUNTING     333 

trust  for  such  bonds  requires  the  corporation  to  set  aside  each 
year  a  designated  amount  of  money  which  is  rehed  upon  to 
accumulate  to  an  amount  equal  to  the  face  value  of  the  bonds 
prior  to  the  date  of  maturity.  The  money  so  set  aside  is  com- 
monly invested  in  securities  which  can  be  readily  sold.  The 
interest  on  such  securities  held  in  a  sinking  fund  is  accumulated 
in  the  fund  on  a  compound  interest  basis.  The  deed  of  trust 
under  which  such  bonds  are  issued  designates  not  only  the 
amount  of  the  annual  contribution  which  must  be  made  to  the 
sinking  fund,  but  has  provisions  in  regard  to  the  type  of  assets 
which  may  be  purchased  with  funds  so  accumulated. 

7.  Charter  and  By-laws  of  the  Corporation.  —  Corporations 
are  commonly  organized  under  the  provisions  of  the  laws  of 
some  state,  which  places  limitations  upon  the  corporation  as  to 
its  operations  and  as  to  the  liabilities  which  it  may  assume. 
Three  or  more  individuals  wishing  to  organize  a  corporation 
must,  therefore,  commonly  apply  to  the  secretary  of  state  for 
authority  to  do  so.  These  individuals  are  required  to  state  the 
purposes  for  which  they  wish  to  organize  the  corporation  and 
to  comply  with  other  formalities  in  connection  with  their  ap- 
plication before  the  secretary  of  state  will  issue  a  charter  to 
the  parties  presenting  application.  When  a  charter  has  been 
secured  and  the  capital  stock  has  been  subscribed  for  and  paid  in 
in  accordance  with  the  laws  of  the  state  under  which  the  cor- 
poration is  organized,  the  stockholders  are  then  called  together 
for  the  purpose  of  perfecting  the  organization  of  the  business 
which  is  provided  for  in  the  charter.  A  set  of  by-laws  is  ordi- 
narily adopted,  which  designates  the  offices  of  the  corporation 
and  the  rights  and  duties  attached  to  the  respective  offices 
created.  The  charter  also  commonly  provides  for  a  board  of 
directors  to  whom  the  stockholders  delegate  general  managerial 
authority.  The  board  of  directors  is  also  entrusted  with  the 
duty  of  employing  officers  to  carry  on  the  routine  operations  of 
the  corporation.  The  directors  are  then  expected  to  meet  from 
time  to  time,  to  pass  on  the  proposals  made  by  the  officers  of 
the  corporation  in  regard  to  the  conduct  of  its  business.  The 
officers  of  the  corporation  are  required  to  carry  out  the  instruc- 


334  AccouxrrxG  principles 

tions  of  the  board  of  directors  and  to  carrv'  on  the  business  in 
accordance  with  the  by-laws  of  the  corporation  and  the  instruc- 
tions of  the  board  of  directors.  The  stockholders  themselves 
generally  have  an  annual  meeting  for  the  purpose  of  deciding 
such  general  questions  of  management  as  may  not  be  dele- 
gated to  the  board  of  directors.  Moreover,  the  stockholders 
will  yearly  elect  additional  directors  to  fill  the  places  of  those 
directors  whose  terms  may  have  expired.  For  a  fuller  descrip- 
tion of  the  nature  and  content  of  the  by-laws  of  the  corporation, 
the  student  is  referred  to  the  texts  on  corporation  finance. 

8.  Distribution  of  Profits.  —  The  stockholders  commonly 
del^ate  to  the  directors  of  the  corpwration  the  determination 
of  the  amoimt  of  profits  which  are  to  be  distributed  from  time 
to  time  to  the  stockholders.  K  it  should  appear  that  the  di- 
rectors are  withholding  profits  from  distribution  unnecessarily, 
the  aggrieved  stockholders  might  apply  to  a  court  of  equity  for 
an  injunction  which  would  require  the  directors  to  distribute 
the  profits  to  which  the  stockholders  might  be  entitled.  Wide 
discretion  is,  however,  commonly  given  to  the  directors  in  de- 
termining whether  the  interests  of  the  corporation  require  the 
retention  of  profits  for  an  expansion  of  the  operations  of  the 
corporation. 

9.  Minute  Book.  —  The  by-laws  of  the  corporation  would 
commonly  require  that  a  minute  book  be  kept,  in  which  a' full 
record  is  made  of  all  the  resolutions  and  proceedings  of  the 
board  of  directors.  The  record  set  forth  in  this  minute  book  is 
the  authority  upon  which  the  officers  of  the  corporation  pro- 
ceed in  carrN^ing  forward  the  business  of  the  corporation. 

ID.  Nature  of  the  Corporate  Organization.  —  It  will  appear 
from  the  previous  description  of  the  characteristics  of  the  cor- 
poration that  it  is  a  highly  developed  tyjje  of  business  organi- 
zation designed  primarily  for  the  raising  of  adequate  funds  for 
canydng  forward  and  expanding  the  operations  of  a  business. 
The  various  classes  of  claims  created  against  the  assets  of 
the  corporation  are  designed  to  meet  the  requirements  and 
preferences  of  the  \'arious  types  of  investors  who  may  have 
money  available  for  business  investments.     If  the  investor 


CORPORATE  ORGANIZATION  AND  ACCOUNTING      335 

desires  to  have  authority  to  determine  the  general  policies  of 
the  business  with  which  he  is  connected  and  at  the  same  time 
to  share  in  the  profits  of  the  enterprise  he  will  invest  in  corpo- 
rate stock.  If  he  is  a  holder  of  common  stock  he  wil',  in  gen- 
eral, have  a  vote  in  the  election  of  the  board  of  directors  and 
he  will  have  certain  rights  in  regard  to  inquiry  into  the  opera- 
tions of  the  business  with  which  he  is  associated  and  he  will 
also  have  the  right  to  a  share  in  the  profits  of  the  business.  If 
he  is  a  holder  of  preferred  stock,  he  may  have  a  vote  in  the 
election  of  directors  and  certain  rights  in  regard  to  directing 
the  affairs  of  the  business,  or  he  may  be  deprived  of  this  right 
by  the  articles  under  which  the  preferred  stock  is  issued.  In 
any  case,  however,  his  investment  will  be  attended  with  less 
risk  than  that  connected  with  the  ownership  of  common  stock. 
There  will  be  less  risk  still  connected  with  the  ownership  of 
bonds,  and  the  safest  bond,  in  general,  is  the  first  mortgage 
bond.  The  investor  who  desires  a  safe  investment  requiring 
little  attention  on  his  part  will  commonly  select  a  high  class 
first  mortgage.  This  variety  of  investment  opportunity  created 
by  the  corporation  makes  it  the  favorite  device  for  the  financ- 
ing of  business  enterprise  on  a  large  scale. 

II.  The  Relation  of  Corporate  Organization  to  Accounting 
Procedure.  —  The  accountant  could  not  intelligently  proceed 
to  set  up  a  schedule  of  accounts  until  he  had  first  familiarized 
himself  with  the  tjpes  of  securities  authorized  by  the  charter, 
by-laws,  and  directors  of  the  corporation.  Moreover,  the  audi- 
tor would  need  to  familiarize  himself  with  the  provisions  of  all 
deeds  of  trust  and  of  all  instruments  under  which  the  various 
types  of  liabihties  and  shares  are  issued.  He  would  need  to 
know  these  facts  both  from  the  standpoint  of  determining  what 
information  should  be  recorded  in  the  corporate  books  and  also 
for  the  purpose  of  determining  whether  the  officers  and  di- 
rectors of  the  corporation  were  carrying  on  its  operations  in 
accordance  with  the  provisions  of  these  instruments  designed  to 
protect  the  various  investors  interested  in  the  property.  The 
accountant  must  not  only  be  familiar  with  the  contents  of  all 
the  instruments   creating    liabilities   and  proprietary   claims, 


336  ACCOUNTING  PRINCIPLES 

but  he  must  also  be  familiar  with  all  actions  taken  by  the  board 
of  directors  as  recorded  in  the  minute  book  of  the  corporation. 
The  proceedings  of  the  directors  may  at  any  time  require  that 
certain  accounts  be  set  up  or  that  certain  records  be  initiated 
which  have  not  heretofore  been  foimd  in  the  accounts  of  the 
corporation. 

12.  Corporate  Accotmting.  —  The  income,  expense,  and  asset 
accounts  are  similar  to  the  accounts  under  these  various  head- 
ings in  the  partnership  and  individual  business  of  a  similar  size 
and  character.  The  peculiar  features  of  corporate  accounting 
arise  in  connection  with  the  proprietary  and  liability  interests. 
These  interests  are  complex  and  the  officers  and  directors  need 
to  be  fully  acquainted  at  all  times  with  the  character  and 
amount  of  liabilities  to  holders  of  securities  of  every  class. 
They  also  need  to  know  the  obligations  to  the  corporation 
which  the  holders  of  subscription  claims  and  corporate  securi- 
ties may  have.  The  corporation  reports  of  income  and  ex- 
pense and  the  classification  of  assets  as  found  in  corporation 
reports  present  no  special  characteristics  as  compared  with 
those  of  the  types  of  business  which  have  been  so  far  consid- 
ered. 

13.  The  Corporate  Balance  Sheet.  —  The  balance  sheet  of 
the  corporation,  which  is  presented  in  outline  below,  shows  in 
summarized  form  how  the  facts  of  corporate  liabilities  and  pro- 
prietorship are  presented  for  the  purpose  of  an  operating  con- 
cern. The  corporate  balance  sheet  presents  the  financial  situ- 
ation of  the  corporation.  The  ratios  of  current  assets  to  cur- 
rent liabilities,  net  worth  to  fixed  assets,  etc.,  have  a  signifi- 
cance similar  to  that  already  pointed  out  in  a  preceding  chap- 
ter. The  caption  of  fixed  habilities  has  far  more  importance, 
however,  in  the  corporate  balance  sheet  than  it  has  in  the  other 
forms  of  organization  because  this  type  of  investment  interest 
is  larger  as  compared  with  proprietary  investments  than  for 
the  partnership  and  the  individual  business.  There  is  present 
the  temptation  to  issue  a  large  total  of  fixed  liabilities  in  the 
form  of  bonds  and  mortgages  as  compared  with  the  total  pro- 
prietorship investment.     The  holders  of  the  fixed  liabihties 


CORPORATE  ORGANIZATION  AND  ACCOUNTING     337 

commonly  have  the  right  to  displace  the  proprietorship  in  the 
management  of  the  corporation  in  case  it  does  not  prove  to  be 
able  to  pay  the  interest  charges  and  also  pay  the  liabilities 
when  they  fall  due.  The  holders  of  bonds  and  mortgages  ordi- 
narily get  control  through  the  appointment  of  a  receiver,  who 
operates  the  property  with  a  view  to  meeting  their  claims,  or 
the  receiver  may  undertake  to  sell  the  property  with  the  view 
to  paying  the  claims  of  the  holders  of  liability  interests.  If  the 
court  appoints  the  receiver  on  the  application  of  the  bond  or 
mortgage  holders,  the  receiver  is  required  to  act  on  instructions 
from  the  court  in  his  operation  or  sale  of  the  property.  If  the 
property  is  sold  for  no  more  than  enough  to  pay  the  obligations 
of  the  corporation  to  its  creditors  the  proprietary  interest  loses 
its  entire  investment. 

In  organizing  the  corporation,  therefore,  the  proprietors 
should  be  cautious  not  to  create  fixed  interest  charges  so  large 
in  amount  that  the  total  income  of  the  corporation  may  in  the 
years  of  dull  business  be  insufficient  to  pay  them.  The  margin 
of  total  income  over  the  amount  required  to  meet  these  guar- 
anteed claims  should  be  so  large  that  there  will  be  little  chance 
for  the  proprietary  interest  to  lose  its  investment.  The  ratio 
of  fixed  habi  ities  to  the  proprietary  interest  should  be  smallest 
in  those  lines  of  industries  in  which  the  total  income  fluctuates 
widely  from  year  to  year.  A  street  railway's  income  does  not 
generally  fluctuate  so  widely  as  the  income  of  the  industrial 
corporations.  It  is  not  uncommon  for  the  street  railway  to  be 
constructed  mainly  from  the  proceeds  of  bond  sales.  The  in- 
dustrial organized  on  such  a  basis  would  be  in  an  imstable 
position  both  from  the  standpoint  of  the  creditors  and  of  the 
proprietary  interest. 

A  similar  analysis  may  be  made  from  the  standpoint  of  the 
relation  of  the  appropriate  amount  of  investment  of  the  com- 
mon stockholders  as  compared  with  that  of  the  holders  of  the 
preferred  shares.  If  one  interested  in  such  analysis  had  a  large 
number  of  corporate  statements  in  each  industry,  some  conclu- 
sion might  be  reached  as  to  the  prevailing  ratio  of  fixed  lia- 
bilities to  proprietorship  in  the  respective  industries. 


338  ACCOUNTING   PRINCIPLES 

The  sale  value  of  the  proprietary  mterest  may  be,  at  the 
time  of  the  organization  of  the  business,  much  less  than  its 
nominal  or  face  v'ulue.  The  full  analysis  of  the  actual  invest- 
ment of  the  proprietors  as  compared  with  the  nominal  value  of 
the  shares  may  be  secured  in  the  first  instance  by  a  far  valua- 
tion of  the  assets  turned  over  to  the  corporation  in  exchange 
for  the  shares  as  shown  by  the  journal  entries  involved  in  the 
issue  of  the  corporate  shares.  The  additional  funds  invested 
from  year  to  year  would  generally  be  shown  by  the  corporate 
surplus  if  no  further  shares  were  issued. 

For  a  detailed  analysis  of  the  factors  connected  with  the  or- 
ganization and  capitalization  of  the  corporation  the  student  is 
referred  to  the  texts  on  corporation  finance. 

The  following  balance  sheet  outline  shows  the  more  staple 
items  and  groups  of  items  found  in  the  corporate  balance  sheet: 


ILLUSTRATION  NO.   27 

VALLEY  FURNITURE  COMPANY 

Comparative  Balance  Sheet,  December  31,  19 — 

(The  per  cents  other  than  increase  per  cents  are  of  total  assets  or 


Current  Assets: 

Cash 

Notes  Receivable  .  .  . 
Accounts  Receivable  .  . 
Merchandise  Inventory  . 
Accrued  Inc.    Not  Due: . 

Interest     

Rent 

Totals 

Working  Assets: 

Supplies  Inventory  .  . 
Deferred  Expense: 

Insurance  

Ext.  Repairs  .  .  .  . 
Advances  to  Agents  .  . 
Totals 

Investment  of  Reserves: 
Bond  Sinking  Fund    .     . 
Replacement  Fund     .     . 
Totals 

Permanent  Investments: 
Securities  in  A.  B.  C.  Co. 
Advances  to  G.  H.  Co.    . 
Totals 

Fixed  Assets: 

Land 

Buildings 

Furniture  and  Fixtures 

Plant   

Eqixipment    .... 

Goodwill 

Totals 

Grand  Total  Assets   .     . 


total  liabilities) 

Assets 

1918 


1917 


Increase 


Inc.  % 


339 


340 


ACCOUNTING  PRINCIPLES 


Current  Liabilities: 
Notes  Payable  .     .     .     . 
Accounts  Payable  .     .     . 
Accrued  Accts.  Payable: 

Interest 

Rent 

Taxes 

Totals 

Deferred  Inconae: 

Royalties 

Rent 

Totals 


Fixed  Liabilities: 

Bonds 

Mortgages     .... 
Notes  (Long  term) 
Totals 

Proprietorship: 

Capital  Stock,  Common 
Capital  Stock,  Preferred 
Appropriated  Surplus 

Surplus 

Totals 

Grand  Total  Liabilities  . 


Liabilities 
1918 


1917 


Increase 


Inc.% 


QUESTIONS  AND  PROBLEMS 

1.  In  the  corporation  how  is  the  original  proprietary  interest  created 
and  designated? 

2.  What  is  meant  by  par  value? 

3.  What  are  the  advantages  of  shares  without  par  value?  What  credits 
to  capital  would  arise  out  of  their  sale? 

4.  What  becomes  of  the  net  profits  of  the  corporation? 

5.  (a)  Describe  the  nature  of  corporation  di\-idends.  (b)  Who  gener- 
ally has  authority  to  declare  them?  (c)  From  what  account  are  they  com- 
monly declared? 


CORPORATE  ORGANIZATION  AND  ACCOUNTING     341 

6.  (a)  What  are  the  liabilities  of  the  shareholders  of  the  ordinary  pri- 
vate corporation?    (b)  Of  the  national  bank  shareholders? 

7.  (a)  What  are  the  classes  of  corporate  shares?    (b)  Describe  the  rights 
generally  belonging  to  the  various  types  of  shares. 

8.  Describe  the  nature  of  the  bond  liabilities  and  the  process  of  their 
issue. 

9.  (a)  What  are  the  classes  of  bonds?     (b)  What  are  the  rights  of  the 
owners  of  these  several  classes? 

10.  What  instruments  determine  the  rights  and  duties  of  directors,  oiE- 
cers,  and  stockholders? 

12.  What  is  the  content  of  the  minute  book? 

13.  What  are  generally  the  duties  of  the  directors? 

14.  Compare  the  corporate  balance  sheet  with  that  of  the  individual 
business  and  that  of  the  partnership. 


CHAPTER  XXV 

CAPITAL    STOCK   ACCOUNTS   AND   THE   ISSUE   OF   CORPO- 
RATE  SHARES 

I.  Issue  of  Capital  Stock.  —  The  private  corporations  are  in 
general  organized  under  the  laws  of  the  several  states.  Each 
state  makes  certain  requirements  in  regard  to  reports,  in  re- 
gard to  the  maximum  liabiUty  of  the  corporation  and  the 
duties  of  shareholders,  which  must  be  complied  with  by  all 
corporations  organizing  imder  the  laws  of  the  state  in  question. 
The  general  corporation  laws  of  some  states  are  more  favorable 
to  a  corporation  than  those  of  other  states.  It  is  consequently 
adxdsable  before  making  application  to  the  secretary  of  state 
for  articles  of  incorporation  to  become  acquainted  with  the  cor- 
poration laws  of  the  state  in  question,  -\fter  these  prelimi- 
naries have  been  carried  out,  three  or  more  individuals  make 
application  for  the  right  to  incorporate,  stating  the  character  of 
business  to  be  done,  the  amount  of  capital  which  is  to  be  au- 
thorized, and  stating  such  other  facts  as  may  be  required  of 
prospective  incorporators  by  the  laws  of  the  state  imder  which 
the  corporation  is  to  be  organized.  WTien  the  charter  has  been 
seciured,  and  the  preliminaries  in  regard  to  the  formation  of  the 
corporation  have  been  complied  with  by  the  incorporators,  a 
prospectus  is  commonly  issued  indicating  to  prospective  sub- 
scribers for  corporate  shares  the  tv-pe  of  business  to  be  carried 
on  and  the  rights  of  shareholders  in  the  corporation.  A  regu- 
lar blank  form  is  generally  provided  on  which  a  subscriber 
makes  his  subscription  for  a  certain  number  of  shares  of  stock 
and  promises  to  make  pa>-ment  for  the  same  as  required  by  the 
subscription  blank  in  question.  A  Ust  of  subscribers  is  thus 
developed  and  this  list  of  subscribers  is  the  basis  of  setting  up  a 
general  ledger  account  with  subscribers.  At  the  same  time  a 
capital  stock  account  is  set  up  on  the  general  ledger,  subsidiary 

342 


CAPITAL   STOCK  ACCOUNTS  343 

ledgers  showing  in  detail  the  accounts  with  the  particular  sub- 
scribers and  particular  shareholders. 

2.  Entry  of  Authorized  Shares.  —  When  the  capital  stock  of 
the  corporation  is  duly  authorized,  it  is  common  to  make  a 
general  journal  entry  charging  unissued  stock  or  unsubscribed 
stock  and  crediting  capital  stock  for  the  amount  of  capital  au- 
thorized. For  example,  if  $500,000.00  of  capital  stock  were 
authorized  and  no  subscriptions  had  been  taken,  the  journal 
entry  representing  this  fact  would  be  as  follows: 

Unissued  Stock  500,000.00 

Capital  Stock  500,000.00 

Entry  of  authorized  capital 

An  alternative  entry  here  would  be: 

Unsubscribed  Stock  500,000.00 

Capital  Stock  500,000.00 

3.  Entry  of  Capital  Stock  Subscriptions.  —  Let  us  suppose 
in  the  case  above  cited  that  the  following  list  of  subscribers  is 
made  up  from  the  subscription  blanks: 

John  Smith  2500  shares 

John  Quade  1250  shares 

Henry  Post  1000  shares 

Let  us  further  suppose  that  this  subscription  is  accompanied 
by  a  cash  payment  of  10  per  cent  on  the  amount  subscribed. 
The  journal  entry  involved  in  entering  these  subscriptions 
might  be  made  according  to  several  different  methods.  Per- 
haps the  most  common  journal  entry  would  be  the  following: 

Subscribers  475,000.00 

John  Smith  250,000.00 
John  Quade  125,000.00 
Henry  Post       ioo,ooo.co 

Unissued  Stock  475,000.00 

An  alternative  entry  which  might  be  substituted  along  with 
the  alternative  entry  in  the  preceding  paragraph  would  be  as 
follows: 


344  ACCOUNTING  PRINCIPLES 

Subscribers  475,cxx>.oo 

John  Smith       250,000.00 
John  Quade      125.000.00 
Henry  Post       100,000.00 
Unsubscribed  Stock  475,000.00 

At  the  same  time  it  would  be  necessarj'  to  make  a  second  entn- 
covering  the  cash  received,  as  follows: 


Cash 

47,500.00 

Subscribers 

47,500.00 

John  Smith 

25,000.00 

John  Quade 

12,500.00 

Henry  Post 

10,000.00 

Other  payments  of  the  subscribers  under  the  requirements  on 
their  subscription  blanks  would  be  entered  in  the  same  fashion 
as  the  10  per  cent  paid  at  the  time  of  the  original  subscription. 
In  case  property  were  turned  over  to  the  corporation  by  cer- 
tain shareholders  in  payment  for  their  subscriptions,  the  proj>- 
erty  so  transferred  would  be  charged,  and  the  subscription  ac- 
count in  question  credited.  It  might  be  true  that  certain  sub- 
scribers who  exchanged  property  for  shares  would  receive  fully 
paid  stock  covering  the  valuation  placed  on  the  property  re- 
ceived. If  it  be  supposed  that  John  Quade  were  allowed  $10,- 
000.00  for  patent  rights,  he  might  be  given  paid-up  shares  for 
$10,000.00,  or  the  valuation  placed  on  his  patent  rights  trans- 
ferred to  the  corporation  might  be  credited  to  the  subscription 
accoimt  as  follows: 

Patent  Rights  *  10,000.00 

Subscribers  10,000.00 

(John  Quade) 

Crediting  John  Quade  on  his  sub- 
scription account  for  patent 
rights  transferred  to  the  cor- 
poration 

4.  Definition  of  Unissued  Capital  and  Capital  Stock  Ac- 
coiints.  —  If  the  entry  be  made  as  provided  for  in  the  preced- 
ing paragraph,  the  imissued  stock  accoimt  would  be  described 
as  follows: 


CAPITAL  STOCK  ACCOUNTS 
UNISSUED   STOCK 


345 


Total  Authorized  Stock  Unissued 
Balance  of  Unsubscribed  Stock 


Total  Capital  Stock  Subscribed 


The  unsubscribed  stock  referred  to  as  an  alternative  entry 
would  be  described  in  the  same  way.    The  two  accounts  mean 
the  same  but  the  alternative  account  is  more  satisfactory  as 
descriptive  of  the  item. 
The  capital  stock  account  would  be  described  as  follows: 


CAPITAL   STOCK 


Reductions  in  Capital  Stock 
Balance  Authorized 


Total  Capital  Authorized 


Under  this  plan  the  capital  stock  account  in  the  case  of  the 
corporation  above  described  would  appear  on  the  liability  side 
of  the  balance  sheet  as  follows: 

Capital  Stock  $500,000.00 

Less  Unissued  Stock  (Or  Unsubscribed)  25,000.00      $475,000.00 

Objection  is  sometimes  made  to  the  fact  that  stock  is  repre- 
sented as  corporation  capital  before  the  subscriptions  are  fully 
paid.  The  shareholders  do  not  commonly  have  even  the  vot- 
ing right  until  the  subscriptions  have  been  fully  paid.  More- 
over, it  is  contended  that  the  capital  stock  account  with  the 
deductions  of  unissued  shares  should  be  so  stated  as  to  show 
the  proprietary  investment  made  in  connection  with  the  or- 
ganization of  the  corporation.  On  the  other  hand,  it  is  con- 
tended that  the  subscriptions  of  the  prospective  shareholders 
represent  for  the  time  being  their  investment  in  the  capital  of 
the  corporation  and  that  the  balance  of  the  subscribers'  ac- 
count will  at  all  times  show  the  balance  to  be  paid  on  sub- 
scriptions and  that  hence  all  the  facts  are  fully  set  forth  that 


346  ACCOUNTING  PRINCIPLES 

would  be  needed  by  any  creditor  of  the  corporation,  by  refer- 
ence to  the  balance  of  the  capital  stock  account  after  the  de- 
duction of  the  unissued  or  unsubscribed  stock. 

It  is  preferred,  however,  by  some  that  a  different  definition 
shall  be  given  to  unissued  capital  stock  and  that  another  ac- 
count shall  be  introduced  called  capUal  stock  subscriptions.  If 
this  second  method  of  opening  entry  were  adopted  the  trans- 
actions above  described  would  be  entered  as  follows: 

(a)  Unissued  Capital  Stock  500,000.00 

Capital  Stock  500,000.00 

(b)  Subscribers  475,000.00 

(Detail  list  of  subscribers  as  above) 

Capital  Stock  Subscriptions  475,000.00 

'c)   Cash  47,500.00 

Subscribers  47,500.00 

(Detail  credit  to  particular  subscribers) 

Finally  when  all  subscriptions  to  the  $475,000.00  of  capital 
stock  have  been  fully  paid,  an  entry  would  be  made  as  follows: 

(d)  Capital  Stock  Subscriptions       475,000.00 

Unissued  Capital  Stock  475,000.00 

This  set  of  entries  involved  in  entering  subscriptions  is  more 
accurate  in  some  particulars  and  conveys  on  the  face  of  a  bal- 
ance sheet  during  the  period  when  subscriptions  are  being  paid 
more  information  than  the  first  method  referred  to  above.  In 
this  case  the  balance  of  the  imissued  capital  stock  account 
would  always  show  the  amount  of  stock  unissued  (not  out- 
standing). The  capital  stock,  less  unissued  stock,  as  it  would 
apf>ear  on  the  balance  sheet  of  the  corporation,  would  then 
show  the  capital  stock  actually  outstanding.  It  is  fair  to  raise 
the  question,  how^ever,  whether  it  is  more  desirable  to  show 
during  this  period  the  actual  stock  outstanding  or  whether  it 
would  be  preferable  to  show  the  original  proprietary  interest 
as  the  capital  stock  for  which  subscriptions  had  been  received. 
5.  Capital  Stock  as  a  Controlling  Account  —  If  it  is  desired 
to  make  the  capital  stock  account  a  controlling  account  over 
the  capital  stock  ledger,  it  would  be  necessary  to  make  no 


CAPITAL  STOCK  ACCOUNTS  347 

credits  to  capital  stock  until  shares  are  fully  paid  and  issued. 
On  the  basis  of  a  program  of  this  character,  the  entries  de- 
scribed above  would  be  made  as  follows: 

(a)  Subscribers  475,000.00 

(List  in  detail  as  above) 
Capital  Stock  Subscriptions  475,000.00 

(b)  Cash  47,500.00 

Subscribers  47,500.00 

(Subscription  credits  in  detail) 

When  the  $475,000.00  of  stock  has  been  fully  paid  the  sub- 
scribers' account  will  be  closed  and  all  of  the  individual  sub- 
scription accounts  will  also  be  closed.  The  entry  under  such 
circumstances  would  be  as  follows: 

(a)  Capital  Stock  Subscriptions       475,000.00 

Capital  Stock  475,000.00 

(Credit  also  individual  accounts  of  each  shareholder) 

Prior  to  the  issue  of  capital  stock  the  account  of  capital  stock 
subscriptions  will  represent  the  proprietary  interest  of  the 
stockholders  in  the  enterprise. 

If  the  subscriptions  are  fully  paid  at  the  time  of  opening  the 
books  of  the  corporation,  it  is  then  unnecessary  to  open  ac- 
counts with  subscribers  or  to  set-up  a  subscribers'  account. 
If  the  subscriptions  are  paid  in  cash  at  the  time  of  opening  the 
books  the  capital  stock  would  be  issued  and  the  journal  entry 
would  be  as  follows: 

Cash  475,000.00 

Capital  Stock  475,000.00 

(Credit  also  individual  accounts  of  each  shareholder) 

If,  however,  it  were  desired  to  credit  capital  stock  with  the 
total  of  the  authorized  issue  instead  of  the  amount  issued,  the 
journal  entry  would  be  made  as  follows: 

Unissued  Stock  25,000.00 

Cash  475,000.00 

Capital  Stock  500,000.00 

With  the  last  entry  the  capital  stock  account  would  not  be  a 
controlling  account  over  the  stock  ledger,  although  reference  to 


348  ACCOUNTING  PRINCIPLES 

unissued  stock  would  readily  show  the  amount  of  stock  out- 
standing, which  could  be  checked  against  the  detail  stock 
ledger  accounts  to  see  whether  the  capital  stock  account  in  the 
general  ledger  was  in  accord  with  the  stock  ledger  and  other 
entries  affecting  capital  stock. 

6.  Installment  Records.  —  Even  though  subscription  to  cap- 
ital stock  is  paid  in  installments,  it  does  not  seem  necessary  to 
set  up  each  installment  as  a  separate  subscription  account. 
The  pa3'^ment  of  installment  No.  i  can  be  credited  to  the  sub- 
scription account  as  Installment  No.  i;  likewise,  the  payment 
of  installment  No.  2  can  be  credited  to  the  subscription  ac- 
count as  Installment  No.  2.  This  could  be  readily  accom- 
plished by  columns  in  the  cash  journal  headed  Installment  No. 
I  and  Installment  No.  2,  so  that  the  total  received  could  be 
carried  from  the  cash  journal  as  one  item  of  credit  to  the  sub- 
scribers' account  with  a  ledger  memorandum  showing  the 
amount  collected  on  Installment  No.  i.  Likewise  the  credits 
to  the  individual  accounts  of  subscribers  in  the  subscription 
ledger  might  show  in  the  memorandum  that  the  credit  was  for 
Installment  i,  2,  or  3. 

However,  it  is  sometimes  desired  to  set  up  a  separate  ac- 
count in  the  general  ledger,  for  each  installment  and  at  the 
same  time  to  charge  the  subscribers  with  the  special  install- 
ments so  that  for  each  subscriber  there  would  be  as  many 
subscription  accounts  as  there  are  installments  and  as  many 
general  subscription  accounts  in  the  general  ledger  as  there  are 
installments.  Let  us  suppose  that  the  $475,000.00  subscrip- 
tions referred  to  above  were  in  three  installments  of  10  per 
cent,  45  per  cent,  and  45  per  cent.  In  that  case  the  subscrib- 
ers' account  might  be  closed  out  into  the  respective  installment 
accounts  by  the  following  journal  entry: 

Installment  #1  47,500.00 

Installment  #2  213,750.00 

Installment  #3  213,750.00 
Subscribers  475,000.00 

In  connection  with  each  charge  to  the  Installment  Accounts 
the  detail  charges  to  individual  subscribers  should  be  made. 


CAPITAL   STOCK  ACCOUNTS  349 

The  individual  accounts  would  in  each  case  be  divided  into 
three  in  the  same  proportion  as  that  indicated  for  the  total  of 
subscriptions.  If  $47,500.00  of  cash  were  received  on  install- 
ment No.  I  the  journal  entry  showing  the  receipt  would  be  as 
follows : 

Cash  47,500.00 

Installment  #1  47,500.00 

Credits  to  the  subsidiary  ac- 
counts would  be  made  here 
also 

Individual  installment  accounts  would  likewise  be  credited  for 
the  first  installment. 

7.  Exchange  of  Property  for  Stock.  —  It  happens  frequently 
that  a  corporation  takes  over  the  property  of  some  other  busi- 
ness, assuming  its  liabilities  and  exchanging  shares  to  the  pro- 
prietors of  the  old  business  for  their  interest.  For  example,  the 
ABC  Corporation  might 'issue  shares  to  D  and  C,  who  are 
partners  in  a  firm  with  the  following  balance  sheet: 


D&C   FIRM 

Balance  Sheet,  December  31,  1919 

Assets 

Current  Assets: 

Cash 

$10,000.00 

Notes  Receivable 

4,000.00 

Accoimts  Receivable 

17,500.00 

Merchandise  Inventory 

15,000.00 

$46,500.00 

Fixed  Assets: 

Fixtures 

5,000.00 

Total  Assets 

Liabilities 

$51,500.00 

Current  Liabilities: 

Notes  Payable 

$7,500.00 

Accounts  Payable 

12,000.00 

$19,500.00 

Proprietorship : 
C's  Capital 

20,000.00 

D's  Capital 

12,000.00 

32,000.00 

Total  Liabilities 

$51,500.00 

350  ACCOUNTING  PRINCIPLES 

It  will  be  seen  that  the  proprietan'  interest  in  the  partnership 
amounted  to  $32,000.00.  If  it  were  desired  by  the  corporation 
to  take  over  the  assets  and  liabilities  at  their  book  valuation, 
then  $32,000.00  of  the  capital  stock  of  the  ABC  Corporation 
would  be  issued  to  C  and  D  for  their  proprietary'  interest,  $20,- 
000.00  to  C  and  $12,000.00  to  D.  In  some  instances,  however, 
the  corporation  might  insist  on  a  reduction  in  the  book  value 
of  some  of  the  asset  items;  accounts  receivable,  merchandise 
inventon.',  or  fixed  assets  might  be  reduced  and  the  proprietary* 
interest  in  the  partnership  would  be  correspondingly  reduced. 
These  adjustments  would  be  made  in  the  books  of  the  old  firm 
prior  to  the  transfer  to  the  corporation.  The  corporation 
would  take  the  assets  over  at  their  readjusted  value  and  would 
exchange  capital  shares  to  the  partnership  in  amount  indicated 
by  the  readjusted  valuation  of  their  partnership  interest.  If 
the  capital  stock  were  issued  in  exchange  for  the  proprietary 
interest,  the  following  journal  entry  might  serve  to  incorporate 
the  business  in  the  books  of  the  corporation: 


Cash 

10.000.00 

Notes  Receivable 

4.000.00 

Accounts  Receivable 

17,500.00 

Merchandise  Inventory 

15,000.00 

Fixtures 

5,000.00 

Notes  Payable 

7,500.00 

Accounts  Payable 

12,000.00 

Capital  Stock 

32,000.00 

C's  Capital     20.000.00 

D's  Capital     12,000.00 

If,  however,  the  books  of  the  corporation  had  been  opened  with 
subscription  accounts  and  some  of  the  subscribers  were  ex- 
pected to  pay  for  their  shares  in  installments,  then  the  part- 
ners in  the  firm  taken  over  would  also  be  represented  as  sub- 
scribers by  means  of  the  following  journal  entr}*: 

Subscribers  3  2 ,000.00 

Capital  Stock  Subscriptions  32,000.00 

Then  the  taking  over  of  the  assets  and  liabiUties  would  be 
recorded  by  the  following  journal  entry: 


CAPITAL  STOCK  ACCOUNTS  351 

Cash  10,000.00 

Notes  Receivable  4,000.00 

Accounts  Receivable  17,500.00 

Merchandise  Inventory  15,000.00 

Fixtures  5,000.00 

Notes  Payable  7,500.00 

Accounts  Payable  12,000.00 

Subscribers  32,000.00 

C,  20,000.00 

D,  12,000.00 

After  this  entry  is  made  and  the  subscriptions  of  C  and  D  are 
fully  paid  the  following  journal  entry  would  be  made: 

Capital  Stock  Subscriptions        32,000.00 

Capital  Stock  32,000.00 

The  student  will  readily  see  how  these  items  would  appear  on 
the  books  of  the  corporation  if  any  one  of  the  plans  referred  to 
in  the  preceding  paragraphs  were  adopted  for  the  opening  entries. 
Accountants  frequently  insist  on  a  still  further  analysis  for 
indicating  the  opening  entries  of  the  corporation,  showing  in 
separate  entries  the  assets  taken  over,  the  liabilities  assumed; 
and  the  transfer  of  the  proprietary  interest.  The  detail  would 
require  journal  entries  as  follows:^ 

(a)  Cash  10,000.00 
Notes  Receivable  4,000.00 
Accounts  Receivable  17,500.00 
Merchandise  Inventory  15,000.00 
Fixtures  5,000.00 

C  and  D,  vendors  51,500.00 

Entries  of  the  purchase  from 
C  and  D  of  the  assets  of 
the  partnership 

(b)  C  and  D,  vendors  19,500.00 

Notes  Receivable  7,500.00 

Accounts  Payable  12,000.00 

Entry  showing  the  assump- 
tion of  the  partnership 
liabilities  by  the  corpora- 
tion 

(c)  C  and  D,  vendors  32,000.00 

Capital  Stock  32,000.00 

1  Again,  if  it  were  desired  to  enter  C  and  D  as  subscribers  this  entry  would  be  made  before 
any  of  the  entries  recorded  above. 


CHAPTER  XXVI 
CHANGING  TO  THE  CORPORATE  FORM  OF  ORGANIZATION 

I.  Transferring  Entries  on  the  Old  Books.  —  If  an  individual 
or  partnership  business  is  changed  to  the  corporate  form  and 
the  operating  records  used  for  the  old  business  are  continued, 
the  entries  required  to  indicate  the  change  will  be  simple.  Sup)- 
pose  the  partners  A  and  B  decide  to  incorporate  with  a  capital 
stock  of  $10,000.00  in  excess  of  their  total  capital.  A's  capital 
is  $40,000.00  and  B's  is  $50,000.00,  while  the  authorized  capital 
of  the  corporation  is  $100,000.00.  Since  the  assets  less  the  lia- 
bilities are  $90,000.00,  it  is  necessary-  either  to  start  with  a  defi- 
cit or  to  introduce  an  item  of  goodwill.  If  profits  and  losses  were 
divided  equally  in  the  old  business,  the  $10,000.00  of  goodwill 
would  be  divided  equally  between  A  and  B  by  the  following 
journal  entry: 

Goodwill  10,000.00 

A's  Capital  5,000.00 

B's  Capital  5,000.00 

Goodwill  placed  on  the  partner- 
ship books  as  set  up  in  accord- 
ance with  the  purchase  price 
placed  on  the  assets  by  the 
corporation  which  took  over 
the  assets 

After  the  goodwill  has  been  placed  on  the  books,  it  is  then 
necessary  to  close  out  the  partnership  accounts  and  open  the 
capital  stock  account  by  the  following  journal  entry: 

A's  Capital  45,000.00 

B's  Capital  55,000.00 

Capital  Stock  100,000.00 

(Capital  Stock  to  A  45,000.00) 

(Capital  Stock  to  B  55,000.00) 

The  memorandum  entry  below  the  capital  stock  entries  would 
serve  to  open  the  subsidiar}-^  stock  ledger  accounts  for  the  indi- 
vidual stockholders  if  such  a  ledger  were  kept. 

352 


CHANGING  TO  THE  CORPORATE  FORM      353 

2.  Transferring  to  a  New  Set  of  Books.  —  Let  us  take  first 
the  simple  case  when  the  partnership  books  are  to  be  closed 
preparatory  to  forming  the  corporation  and  a  new  set  of  books 
is  to  be  opened.  Suppose  the  AB  partnership  has  the  follow- 
ing balance  sheet: 

Balance  Sheet  of  AB  Partnership 

Assets  Liabilities 

Cash  $10,000.00  Notes  Payable  $7,500.00 

Notes  Receivable  4,000.00  Accounts  Payable  12,000.00 

Accounts  Receivable      17,500.00  Capital  Stock  32,000.00 

Merchandise  Inventory  15,000.00 
Fixtures  5,000.00 


$51  .joo.oo  $51,500.00 

The  following  journal  entries  woiild  be  suflficient  to  make  the 
transfer: 

(a)  AB  Corporation  51,500.00 

Cash  10,000.00 

Notes  Receivable  4,000.00 

Accounts  Receivable  17,500.00 

Merchandise  Inventory  15,000.00 

Fixtures  5,000.00 

Transfer  of  the  assets  of  the 
partnership  to  the  AB 
Corporation 

(b)  Notes  Payable  7,500.00 
Accounts  Payable                  12,000.00 

AB  Corporation  19,500.00 

The  AB  Corporation  as- 
sumes the  definite  liabil- 
ities 

To  represent  the  fact  that  the  partners  transfer  their  capital 
interests  in  the  partnership  to  the  corporation  the  following 
entry  may  be  made: 

(c)  A,  Capital  20,000.00 
B,  Capital  12,000.00 

AB  Corporation  32,000.00 

Partners'  capitals  are  trans- 
ferred to  the  Corporation 


354  ACCOUNTING   PRINCIPLES 

If  it  is  desired  to  show  on  the  books  what  the  partners  re- 
ceived for  their  capital,  this  can  be  indicated  as  follows: 

(d)  Corporation  Stock  32,000.00 

AB  Corporation  32,000.00 

Stock  of  the  Corporation 
received  for  distribution 
to  partners 

(e)  A,  Capital  20,000.00 
B,  Capital                             10,000.00 

Corporation  Stock  32,000.00 

Corporation  stock  received 
by  partners  in  exchange 
for  their  capital  interests 

If  entries  (d)  and  (e)  are  used,  they  take  the  place  of  the  (c) 
form  of  entry.  The  two  latter  entries  seem  preferable  because 
they  make  the  picture  more  complete.  If  any  adjusting  entries 
were  required  in  connection  with  the  transfer,  those  would  be 
made  as  in  paragraph  i  above,  before  the  final  closing  entries 
are  made. 

3.  Opening  the  Corporation  Books.  —  All  of  the  necessary 
accounts  for  the  corporation  books  would  be  opened  by  the 
following  journal  entry: 

(a)  Opening  Entries  of  AB  Corporation : 
Cash  10,000.00 

Notes  Receivable  4,000.00 

Accounts  Receivable  1 7 ,  500.00 
Merchandise  Inventory  15,000.00 
Fixtures  5,000.00 

Notes  Payable  7,500.00 

,  Accounts  Payable  12,000.00 

'  Capital  Stock  32,000.00 

(A,  Capital  Stock  20,000.00) 
(B ,  Capital  Stock  12  ,ooo.oc^ 
The  corporation  purchases 
the  ownership  interest  of 
A  and  B,  partners,  by  an 
issue  of  $32,000.00  of 
capital  stock,  takes  over 
the  assets  of  the  partner- 
ship, and  assumes  the  lia- 
bilities 


CHANGING  TO  THE   CORPORATE  FORM  355 

The  memorandum  of  this  journal  entry  refers  to  several 
steps  or  aspects  of  this  transfer.  The  accountants  generally 
advocate  the  portrayal  of  these  steps  in  more  detail  by  dis- 
tinct journal  entries.  If  this  is  done,  the  opening  entries  above 
would  be  accomplished  on  the  books  by  the  following  journal 
entries: 

(b)  Opening  Entries  of  AB  Corporation: 

Subscribers  32,000.00 

(A,  Subscriber    20,000.00) 
(B ,  Subscriber    1 2 ,000.00) 


Capital  Stock 

32,000.00 

Cash 

10,000.00 

Notes  Receivable 

4,000.00 

Accounts  Receivable 

17,500.00 

Merchandise  Inventory 

15,000.00 

Fixtures 

5,000.00 

Notes  Payable 

7,500.00 

Accounts  Payable 

12,000.00 

Subscribers 

32,000.00 

(A,  Subscription  20,000.00) 

(B,  Subscription  12,000.00) 

The  corporation  takes  over  the  assets  and 
assumes  the  definite  liabilities  of  A  and 
B,  partners,  crediting  their  subscrij)- 
tion  accounts  with  the  net  assets 

If  one  desired  to  make  the  capital  stock  account  a  controll- 
ing account  over  the  subsidiary  stock  ledger  the  style  of  opening 
entry  shown  on  the  following  page  would  be  used: 


356  ACCOUNTING  PRINCIPLES 

(c)  Opening  Entries  of  AB  Corporation: 

Subscribers  32,000.00 

•  A,  Subscriber  20,000.00 

B,  Subscriber  12,000.00 

Capital  Stock  Subscriptions  32,000.00 

Cash  10,000.00 

Notes  Receivable  4,000.00 

Accounts  Receivable  17,500.00 

Merchandise  Inventory         15,000.00 
Fixtures  5,000.00 

Notes  Payable  7,500.00 

Accounts  Payable  12,000.00 

Subscribers  32,000.00 

(A,  Subscription  20,000.00) 

(B,  Subscription  12,000.00) 
Coiporation    takes   over   the   assets   and 
assumes  the  definite  liabilities  of  A  and 
B,  jMutners.  crediting  their  subscrip- 
tion accounts  with  the  net  assets 
Capital  Stock  Subscriptions  32,000.00 

Capital  Stock  32,000.00 

(A,  Capital  Stock,  20,000.00) 

(B,  Capital  Stock.  12,000.00) 
Capital  Stock  is  issued  covering  paid  up 
subscriptions 

The  steps  set  forth  in  the  three  entries  above  are:  (a)  sub- 
scription to  the  capital  stock  by  the  partners,  (b)  the  transfer 
of  their  property  in  pa>Tnent  of  their  subscription,  and  (c)  the 
issue  of  stock  covering  the  paid  up  subscriptions.  In  this  form 
of  entry  the  subscribers'  account  is  a  general  ledger  account 
controlling  the  subsidiary  subscriber  accounts  in  the  subscrif)- 
tion  ledger.  The  capital  stock  account  is  a  general  ledger  ac- 
count controlling  the  capital  accounts  of  the  stockholders  in  the 
stock  ledger.  The  transfers  of  stock,  however,  do  not  aflFert 
the  balance  of  stock  outstandmg.  It  is  not,  therefore,  neces- 
sary to  provide  for  the  postings  of  the  total  transfers  to  the 
controlling  account.  The  general  ledger  account  is  affected 
only  by  the  original  issue  of  stock  and  the  cancellation  of  stock. 

Neither  of  the  forms  of  opening  entries  used  above  shows  un- 


CHANGING  TO  THE  CORPORATE  FORM  357 

issued  stock.  If  it  be  supposed  in  the  above  case  that  there  is 
$8,000.00  of  unissued  stock,  this  may  be  shown  on  the  books 
by  the  following  form  of  opening  entry: 

(d)  Opening  Entries  of  AB  Corporation: 
Unissued  (or  Unsub- 
scribed) Stock        40,000.00 
Capital  Stock  40,000.00 

Entering  the  authorized  capital  stock 
Subscribers  32,000.00 

(A,  Subscriber  20,000.00) 
(B,  Subscriber  12,000.00) 

Unissued  (or  Unsub- 
scribed) Stock  32,000.00 
A  and  B  subscribe  for  $32,000.00  of  capital 

stock 

Cash  10,000.00 

Notes  Receivable  4,000.00 

Accounts  Receivable  17,500.00 

Merchandise  Inventory         15,000.00 

Fixtures  5,000.00 

Notes  Payable  7,500.00 

Accounts  Payable  12,000.00 

Subscribers  32,000.00 

(A,  Subscription  20,000.00) 
(B,  Subscription  12,000.00) 

The  corporation  takes  over  the  assets  and 
assumes  the  definite  liabilities  of  A  and 
B,  partners,  crediting  their  subscrip- 
tion accounts  with  the  net  assets 

The  capital  item  on  the  balance  sheet 'would  then  appear  as 
follows: 

Capital  Stock  $40,000.00 

Less  Unissued  (Unsubscribed)  8,000.00    $32,000.00 


If  it  were  desired  to  make  the  proprietary  interest  appear  as 
the  actual  capital  stock  outstanding  rather  than  the  sub- 
scribed capital  the  form  of  opening  entry  would  be  as  follows: 


358  ACCOUNTING  PRINCIPLES 

(e)  Opening  Entries  of  AB  Corporation: 

Unissued  Stock  40,000.00 

Capital  Stock  40.000.00 

Entering  the  authorized  capital  stock 


Subscribers 

32,000.00 

A,  Subscriber  20,000.00 

B,Subscnber  12.000.00 

Stock  Subscriptions 

32.000.00 

A  and  B  subscnbe  for  $32,000.00  of  capital 

stock 

Cash 

10.000.00 

Notes  Receivable 

4,000.00 

Accounts  Receivable 

17.500.00 

Merchandise  Inventorj' 

15.000.00 

Fixtures 

5,000.00 

Notes  Payable 

7.500.00 

.\ccounts  Payable 

12.000.00 

Subscribers 

32,000.00 

(A.  Subscription  20.000.00) 

(B.  Subscription  12.000.00) 
The  corporation  takes  over  the  assets  and 
assvunes  the  definite  liabilities  of  A  and 
B.  partners,  crediting  their  subscrip- 
tion accounts  with  the  net  assets 

The  final  entry  would  then  be  as  follows: 

Stock  Subscriptions  32.000.00 

Unissued  Stock  32,000.00 

Issue  of  certificates  covering  paid  up  sub- 
scriptions 

The  stock  subscription  account  would  then  be  closed,  the 
subscribers'  account  would  then  be  closed,  and  the  unissued 
stock  account  would  have  a  balance  of  $8,000.00.  An  objec- 
tion sometimes  raised  to  this  form  of  entr\'  is  that  the  capital 
stock  accoimt  would  show  a  balance  of  the  authorized  capital 
instead  of  the  amount  of  stock  issued  and  outstanding.  This 
difficulty  may  be  ob\'iated  by  the  following  form  of  statement 
of  capital  stock  in  the  balance  sheet: 


CHANGING  TO  THE  CORPORATE  FORM  359 

Capital  Stock  $40,000.00 

Less  Unissued  Stock  8,000.00 


Capital  Stock  Outstanding  $32,000.00 

The  liability  to  stockholders  is  then  represented  as  $32,000.00 
on  the  amount  of  stock  issued. 

The  form  of    opening  entry  referred  to  in  the  parenthesis 
after  the  unissued  capital  stock  item  above  would  be  as  follows: 

(f)    Unsubscribed  Stock  40,000.00 

Capital  Stock  40,000.00 

The  AB  Corporation  authorizes  $40,000.00 
capital  stock 

Subscribers  32,000.00 

(A,  Subscriber  20,000.00) 
(B,  Subscriber  .12,000.00) 

Unsubscribed   Stock  32,000.00 

A  and  B  subscribe  for  $32,000.00  of  capital 
stock 

Cash  10,000.00 

Notes  Receivable  4,000.00 

Accounts  Receivable  17,500.00 

Merchandise  Inventory         15,000.00 

Fixtures  5,000.00 

Notes  Payable  7,500.00 

Accounts  Payable  12,000.00 

Subscribers  32,000.00 

(A,  Subscriber      20,000.00) 
(B,  Subscriber      12,000.00) 

The  corporation  takes  over  the  assets  and  as- 
sumes the  outside  liabilities  of  A  and  B, 
partners,  crediting  their  subscription  ac- 
counts with  the  net  assets 

When  this  form  of  entry  is  used,  the  capital  stock  statement 
in  the  balance  sheet  would  be  made  as  follows: 

Capital  Stock  $40,000.00 

Less  Unsubscribed  Stock     8,000.00    $32,000.00 

The  unsubscribed  stock  and  the  unissued  stock  are  represented 
above  by  the  same  totals,  but  this  would  not  be  the  case  if  part 


360  ACCOUNTING  PRINCIPLES 

of  the  subscribed  stock  had  not  been  fully  paid.  The  total  of 
unissued  stock  would  exceed  the  total  of  unsubscribed  stock. 

This  form  of  entry  is  in  substance  the  same  as  the  first  one 
(a)  used  above  with  the  exception  that  the  word  unsubscribed 
is  used  instead  of  the  word  unissued. 

There  are  other  forms  of  opening  entries  sometimes  referred 
to  in  the  accounting  texts.  The  capital  stock  account  is  not 
strictly  a  controlling  account  in  the  last  two  forms  of  opening 
entries  used  above,  because  the  item  includes  all  capital  stock 
authorized  while  only  the  capital  stock  issued  would  be  recorded 
in  the  stock  ledger.  The  stock  ledger  would  then  be  a  memo- 
randum ledger.  Its  accuracy  could  be  readily  tested,  however, 
by  a  comparison  in  one  instance  with  capital  stock  less  unis- 
sued stock,  and  in  the  other  instance  by  an  examination  of  the 
subscribers'  account  and  the  unsubscribed  stock  account.  No 
imsubscribed  stock  would  be  issued.  No  subscribed  stock  would 
be  issued  until  it  was  fully  paid. 

If  the  (b)  form  of  opening  entries  were  used,  the  record  of 
authorized  and  unsubscribed  stock  would  be  found  in  the  min- 
ute book.  It  would  also  be  significant  as  a  memorandum  in 
connection  with  the  balance  sheet.  This  form  would  then  be 
entirely  satisfactory  and  would  yield  all  needed  information. 
Forms  (d)  and  (e)  insert  this  memorandum  information  in  the 
journal  entries. 

In  opening  the  corporation  books  the  opening  entries  should 
be  made  and  posted  before  the  entry  of  the  regular  transac- 
tions begins.  The  remainder  of  the  accounting  problems  of  the 
private  corporations  are  substantially  the  same  as  those  of  any 
other  kind  of  business  organization.  The  voucher  record  is 
used  frequently  with  the  books  of  the  corporation,  but  it  may 
be  used  either  with  an  individual  enterprise  or  with  a  partner- 
ship if  the  size  of  the  business  justifies  it. 

4.  Forfeited  Stock.  —  In  some  states  a  subscriber  is  not  al- 
lowed to  forfeit  a  stock  after  he  has  subscribed  for  it.  The 
corporation  and  its  creditors  hold  a  claim  against  the  sub- 
scriber for  the  amount  of  his  subscription  even  if  the  total 
amount  is  not  paid  into  the  corporate  treasury. 


CHANGING  TO  THE  CORPORATE  FORM  361 

In  other  states  the  corporation  may  require  the  subscriber  to 
forfeit  his  stock  in  case  of  failure  to  pay  the  subscription  in- 
stallments. Under  such  circumstances  the  corporation  would 
generally  protect  itself  by  requiring  the  subscriber  to  forfeit 
any  payments  already  made  in  so  far  as  these  payments  might 
be  required  in  bringing  to  the  corporation  the  original  sub- 
scription price  of  the  shares. 

Suppose,  for  example,  that  A  subscribed  for  fifty  shares  of 
stock  with  par  of  $100.00  each,  agreeing  to  pay  therefor  the 
par  value  of  each  share,  and  making  an  initial  payment  of  25 
per  cent,  or  $1,250.00.  He  later  forfeits  the  fifty  shares  and 
they  are  sold  to  B  at  $90.00  per  share.  The  settlement,  which 
would  protect  the  corporation  against  loss,  would  be  journal- 
ized as  follows: 

(a)  Subscriber  5,000.00 
(A's  Subscription  Acct.) 

Unsubscribed  Stock  5,000.00 

Entering  A's  subscription  for  50  shares  of  stock 

(b)  Cash  1,250.00 

Subscribers  1,250.00 

(A's  Subscription  Acct.) 
Crediting  the  controlling  subsidiary  subscrip- 
tion amount  for  A's  payment  on  his  sub- 
scription 

(c)  A's  Account  3,750.00 

Subscribers  3,750.00 

(A's  Subscription  Acct.) 
A  forfeits  his  subscription  and  is  charged  with 
the  balance  of  the  account 

(d)  Subscribers  4,500.00 

(B's  Subscription  Acct.) 

A's  Account  4,500.00 

Crediting  A  with  amount  of  B's  subscription  to 
stock  forfeited  by  A 

(e)  Cash  4,500.00 

Subscribers  4,500.00 

(B's  Subscription) 
Payment  of  B's  subscription  to  forfeited  stock 


362  ACCOUNTING  PRINCIPLES 

(f)  A's  Account  750.00 

Cash  750.00 

Payment  to  A  of  balance  due  from  sale  of  his 
forfeited  subscription 

TTie  (f)  entry  would  close  the  account  with  A,  and  B's  sub- 
scription account  would  be  closed  by  the  (e)  entry.  The  addi- 
tional entries  involved  in  the  issue  of  the  stock  would  be  made 
in  accordance  with  one  of  the  plans  described  above.  If  capi- 
tal stock  had  been  credited  with  the  total  of  the  authorized 
stock  and  no  capital  stock  subscription  had  been  opened,  no 
further  entry  would  be  required. 

QUESTIONS  AND  PROBLEMS 

1.  How  would  goodwill  enter  into  the  books  of  a  partnership  if  its  assets 
were  purchased  by  a  corporation?  On  what  basis  would  it  be  distributed  to 
the  partners? 

2.  If  the  assets  of  a  partnership  be  $200,000.00;  the  liabilities,  $50,000.00; 
the  interests  of  partners  Smith  and  Jones,  $45,000.00  and  $55,000.00,  re- 
spectively; and  the  partners  sell  their  interests  to  a  corporation  J  for  stock 
equal  to  the  book  value  of  their  respective  interests,  make  the  journal  en- 
tries showing  two  ianns  of  transfer  which  would  dose  the  books  of  the 
partnership. 

3.  Make  the  opening  entries  of  the  corporarion  according  to  four  differ- 
ent possible  forms  of  entrj\  WTiich  form  seems  preferable  in  thi<;  case? 
Why? 

4.  Make  the  transferring  entry  on  the  assumption  that  the  corporation 
uses  the  same  books  of  record  as  the  partnership. 

5.  The  partners  in  the  firm  of  Smith  and  Jones  decide  to  incorpmate 
and  operate  their  business  under  the  name  of  the  Star  Mercantile  Company. 
The  partnership  agreement  provided  that  profits  and  losses  should  be  di- 
vided -i  to  Smith  and  }^  to  Jones.  The  balance  sheet  of  the  partnership 
on  December  31  after  the  dosing  entries  for  the  year  had  been  made  and 
profits  dosed  into  the  partners'  accounts  was  as  fc^ws: 

SMITH  &  JONES 
Balance  Sheet,  Decekber  31,  1916 


Cash 

$1,925.00 

Notes  Pa\-able 

$2,000.00 

Notes  Receivable 

2,800.00 

Accounts  Paj-able 

8,170.00 

Accounts  Receivable 

14,420.00 

Jones,  Capital 

14,825.00 

Inventory 

30.000.00 

Smith,  Capital 

27,150.00 

Furniture  and  Fixtxires 

3,000.00 
$52,145.00 

$52,145.00 

CHANGING  TO  THE   CORPORATE  FORM  363 

The  agreement  under  which  the  business  is  to  be  incorporated  provides 
for  the  following: 

(a)  Capital  stock,  $50,000.00,  divided  into  500  shares,  par  value  $100.00. 

(b)  Jones  &  Smith  to  be  paid  for  their  interest  in  the  old  partnership 
with  the  stock  in  the  corporation  at  par,  th?  following  adjustments  to  be 
made  prior  to  the  transfer  of  the  business : 

(i)   10  per  cent  is  to  be  deducted  from  the  inventory  value. 

(2)  5  per  cent  is  to  be  deducted  from  the  value  of  furniture  and  fixtures. 

(3)  The  goodwill  of  the  partnership  is  valued  at  $6,000.00  and  placed  on 

the  books  prior  to  the  transfer. 

(4)  No  cash  is  to  be  turned  over  to  the  corporation.    Smith  is  to  take 

personally  all  cash  excepting  an  amount  sufficient  to  reduce 
Jones'  investment  to  even  hundreds  of  dollars. 

(5)  Jones  &  Smith  jointly  guarantee  collection  of  accounts  receivable. 

(c)  The  stock  remaining  after  the  payment  of  the  partners  for  their  in- 
terest is  subscribed  for  by  Brown,  who  pays  for  his  stock  in  cash. 

Give  the  entries  to  adjust  the  books  of  th";  partnership  and  to  close  out 
the  partnership  business.  Open  the  books  of  the  corpKJration.  Give  the 
balance  sheet  of  the  corporation  after  the  opening  entries  have  been  made. 

(6)  Make  the  opening  entries  on  the  books  of  the  Tajdor  Electric  Com- 
pany, a  concern  which  is  incorporated  according  to  the  following  agreement : 

Capital  stock,  $200,000.00. 

H.  C.  Taylor,  the  promoter  of  the  enterprise,  is  to  receive  shares  to  the 
par  value  of  $100,100.00  for  which  he  is  to  pay  $90,000.00  in  cash  in  two 
equal  installments.  He  is  to  receive  credit  toward  his  subscription  for 
$10,100.00  on  account  of  services  rendered  during  the  process  of  incor- 
poration. Stock  to  the  par  value  of  $40,000.00  is  subscribed  for  by  How- 
ard at  no,  payment  to  be  made  in  two  equal  installments.  Jones  sub- 
scribes for  $10,000.00  at  no,  payment  to  be  made  in  two  equal  installments. 
The  remaining  $49,900.00  of  stock  is  given  to  Smith  in  full  payment  for  his 
electric  lighting  plant. 

Taylor,  Howard,  and  Jones  all  pay  their  first  installment  as  it  comes  due. 
Make  the  entries. 

Taylor  pays  his  second  installment  in  cash;  Howard  pays  $15,000.00  in 
cash  and  gives  a  note  due  in  30  days  for  the  remainder.  Jones  defaults  in 
his  pa>Tnent.  The  stock  subscribed  for  by  Jones  is  sold  by  the  directors  to 
White  at  105.  White  pays  for  the  stock  in  cash,  and  the  directors  refund 
to  Jones  the  amount  of  his  first  payment  above  the  sum  necessarily  retained 
to  protect  the  corporation  against  loss.    Make  the  entries. 

An  appraisal  is  made  of  the  Smith  plant  at  this  point  which  shows  the 
following  facts: 

Land  10,000.00 

Buildings  20,000.00 

Transmission  Lines  15,000.00 

Accounts  Receivable  1,000.00 

Accoimts  Payable  3,000.00 

49,000.00 
Place  the  assets  on  the  books  at  their  appraised  value. 


CHAPTER  XXVII 
BOND   ACCOUNT 

1.  Issue  of  Bonds.  —  WTien  mortgage  bonds  are  issued,  the 
consent  of  the  stockholders  is  first  secured.  Then  a  deed  of  trust 
is  created  fully  describing  the  terms  under  which  the  issue  is 
made  and  a  trustee  is  selected  and  charged  with  the  duty  of 
certifying  all  bonds  proposed  before  they  are  actually  issued  by 
the  corporation.  The  bonds  are  then  prepared  in  due  form 
and  turned  over  to  the  trustee  for  certification  before  they  are 
issued  to  subscribers  who  have  paid  in  full  for  their  bonds. 

2.  Bond  Subscriptions.  —  Bonds  may  be  paid  for  in  full  at 
the  time  of  their  purchase.  In  some  instances,  however,  a 
subscriber  will  have  the  right  of  paying  for  his  bonds  on  the 
installment  plan.  For  brevity,  however,  the  most  usual  entry 
for  an  authorized  issue  of  $500,000.00  of  first  mortgage  bonds, 
$400,000.00  of  which  had  been  subscribed,  would  be  as  follows: 

(a)  Unissued  Bonds  500,000.00 

Bonds  Payable  500,000.00 

Authorization  of  half  million  of  first  mortgage  5 
per  cent  bonds  due  December  31,  1940, 
dated  January  i,  1920,  interest  payable 
January  i  and  July  i 

1      (b)  Bond  Subscribers  400,000.00 

(Subsidiary  subscription  accounts  in  subscrip- 
tion ledger.) 
Unissued  Bonds  400,000.00 

Entry  of  subscription  for  $400,000.00  of  first 
mortgage  5  per  cent  bonds 

(c)  Cash  100,000.00 

Bond  Subscribers  100,000.00 

(Subsidiary  subscription  accounts  credited  also) 

A  more  accurate  description  of  the  accounts  would  require  a 
substitution  of  an  account  of  unsubscribed  bonds  for  that  of  un- 

364 


BOND  ACCOUNT  365 

issued  bonds.  But  the  usage  indicated  in  the  journal  entries  is 
the  more  general  although  it  makes  the  word  "unissued"  mean 
the  same  thing  as  the  word  "unsubscribed."  The  subsidiary 
ledger  for  bond  subscribers  would  be  of  the  same  character  as 
that  for  stock  subscribers  described  in  a  preceding  chapter. 

The  best  usage  would  require  the  bond  item  on  the  liability 
side  of  the  balance  sheet  to  appear  as  follows: 

Bonds  Payable  $500,000.00 

Less  Unissued  100,000.00 


Bonds  Issued  $400,000.00 

When  the  subscriptions  had  been  paid  the  "bonds  issued" 
would  become  the  bonds  outstanding.  There  is  some  contro- 
versy as  to  whether  unissued  bonds  should  be  treated  as  an  asset 
or  as  a  deduction  from  the  liability  as  shown  above  The  mer- 
its of  the  case  are  more  fully  discussed  in  a  paragraph  below. 
Bonds  which  are  simply  authorized  are  preferably  regarded  as 
a  deduction  from  bonds  payable. 

3.  Bond  Discount.  —  Bonds  always  bear  a  fixed  rate  of  in- 
terest which  is  payable  at  stated  times,  annually,  semi-annually, 
or  quarterly.  If  the  nominal  rate  which  the  corporation  prom- 
ises to  pay  on  the  par  or  face  value  of  the  bonds  is  lower  than 
the  acceptable  rate  for  such  loans  the  bonds  cannot  be  sold  for 
the  par  value  but  must  be  sold  at  a  discount.  Let  us  suppose 
that  the  bonds  referred  to  above  bear  4  per  cent  interest  pay- 
able semi-annually,  Jan.  i  and  July  i,  and  bring  only  90  cents 
on  the  dollar  or  sell  at  a  10  per  cent  discount.  Then  the  sale 
would  be  journalized  as  follows: 

Cash  360,000.00 

Bond  Discount  40,000.00 

Bonds  Payable  400,000.00 

4.  Treatment  on  Bond  Discount.  —  The  interest  paid  for 
the  use  of  money  is  the  expense  involved  in  securing  the  loan 
of  the  funds  borrowed.  But  when  the  face  value  of  the  bond 
payable  exceeds  the  amount  of  money  secured  the  cost  of  the 
loan  is  the  interest  plus  the  discount  on  the  bonds.    This  ex- 


366  ACCOUNTING  PRINCIPLES 

cess  in  the  face  of  the  bond  repiesents  interest  paid  in  ad- 
vance. Bond  discount,  therefore,  partakes  of  the  nature  of  a 
deferred  expense  and  should  be  classified  with  the  deferred  ex- 
penses in  the  balance  sheet.  During  the  life  of  the  bonds,  this 
interest  paid  in  advance  is  treated  from  year  to  year  as  insur- 
ance paid  in  advance  has  been  treated.  The  expired  part  of 
the  pa>Tnent  is  marked  off  each  year.  A  rough  calculation  of 
expired  discount  for  each  year  could  be  had  by  dividing  the 
total  discount  by  the  life  of  the  bonds.  However,  a  more  ac- 
curate computation  of  expired  discount  can  be  made  by  the  use 
of  bond  tables  showing  the  yield  of  the  bond  sold  at  a  discount 
or  the  efifective  (true)  interest  received  by  the  investor  and 
paid  by  the  corporation.  Let  us  suppose,  for  example,  that  a 
$1000.00  bond  with  nominal  rate  of  4  per  cent  and  effective 
rate  of  5  per  cent  was  sold  at  $950.00.  The  following  table 
will  show  the  expired  discount  each  year: 

Nom.  Cost  Effective  Nominal  Expired 

Prin.  Prin.  Interest  Interest  Discount 

1,000  950.00  47-50  40.00  7.50 

1,000  957-50  47.87  40.00  7.87 

1,000  965.37  48.26  40.00  8.26 

The  entry  which  the  corporation  would  make  at  the  end  of  the 
first  year  for  the  interest  on  the  Siooo.oo  bond  would  be  as 
follows: 

Interest  47 -SO 

Cash  40.00 

I         Bond  Discount  7.50 

The  effective  rate  is  the  interest  basis  upon  which  the  bonds 
are  sold  and  the  yield  on  the  investment.  In  the  case  above 
cited  the  $950.00  represents  the  actual  investment  made  by  the 
bond  buyer.  The  corporation  pays  effective  interest  on  these 
funds  and  the  amount  of  interest  at  the  effective  rate  repre- 
sents the  interest  cost  to  the  corporation.  Although  the  nomi- 
nal interest  is  $40.00  per  year  the  effective  interest  is  $47.50 
for  the  first  year,  $7.50  of  this  amount  being  expired  discount 
on  the  bonds.    This  accurate  method  of  amortizing  is  referred 


BOND  ACCOUNT 


367 


to  as  the  scientific  method.  The  division  of  the  bond  discount 
by  the  life  of  the  bonds  to  get  the  amount  of  expired  discount 
is  referred  to  as  the  straight  Hne  method. 

If  the  bonds  had  been  purchased  at  a  discount  instead  of 
being  sold,  the  principal  would  be  increased  each  year  as  the 
bond  approached  maturity.  The  amount  of  increase  in  prin- 
cipal each  year  would  be  credited  to  interest.  The  entry  for 
the  first  year  would  be  as  follows: 


Cash 

Bond  Investment 
Interest 


40.00 
7-50 


47-50 


5.  Bond  Premiums.  —  If,  on  the  other  hand,  5  per  cent 
bonds  were  sold  at  $1100.00  on  a  4  per  cent  basis,  i.e.,  to  yield 
4  per  cent,  a  part  of  the  $50.00  of  interest  paid  each  year  would 
be  a  return  of  the  bond  premium.  The  premium  is  like  de- 
ferred income  or  interest  received  in  advance.  The  amount  paid 
as  interest  each  year  is  in  part  a  return  of  the  premium.  The 
purchaser  of  the  bond  pays  money  in  advance  for  the  right  to 
receive  more  each  year  than  the  effective  rate  on  the  par  of 
the  bonds  purchased.  The  seller  of  the  bond  should  credit  his 
interest  account  each  year  with  the  amount  representing  a  re- 
turn of  premium  and  charge  the  bond  premium  with  the  same 
amount.  The  following  table  shows  the  nominal  and  effective 
interest  and  the  excess  of  the  nominal  interest.  This  excess  is 
the  amount  representing  a  return  of  a  part  of  the  premium  re- 
ceived. 


Principal 

Invest. 

Nominal 

Effective 

Excess  of 

Nominal 

Price  of 

Interest 

Interest 

Nominal 

Bond 

per  Year 

per  Year 

Interest 

1,000.00 

1100.00 

50.00 

44.00 

6.00 

1,000.00 

1,094.00 

50.00 

43-76 

6.24 

1,000.00 

1,087.76 

50.00 

43-51 

6.49 

The  payment  of  the  $50.00  nominal  interest  the  first  year 
would  be  journalized  as  foUows: 


Interest 

Premium  on  Bonds 
Cash 


44.00 
6.00 


50.00 


368  ACCOUNTING  PRINCIPLES 

If,  however,  the  corporation  should  purchase  such  a  bond  as 
an  investment  a  part  of  the  interest  received  each  year  would 
be  credited  either  to  premium  on  bonds  or  to  bond  investments 
in  case  the  premium  were  not  carried  as  a  separate  account. 
The  journal  entry  would  be  as  follows: 

Cash  50.00 

Interest  44.00 

Bond  Investment  6.00 

6.  Bond  Investment  Account.  —  W'lien  bonds  are  purchased 
the  date  of  purchase  will  not  in  general  correspond  with  the 
interest  date  of  the  bonds.  There  will  be  accrued  interest  at 
the  date  of  purchase.  For  example,  $5000.00  of  6  per  cent 
bonds,  interest  payable  Jan.  i  and  July  i,  may  be  purchased 
March  15  in  New  York  City.  Interest  has  accrued  for  a  frac- 
tion of  the  half-year  interest  of  3  per  cent.  If  the  bonds  are 
purchased  at  102  and  accrued  interest  the  question  arises  as  to 
the  price  paid.  Since  the  accrual  calculation  here  involves  the 
payment  of  a  money  price,  the  accrued  interest  calculation 
might  be  made  with  accuracy  at  73/181  of  the  3  per  cent  an- 
nual interest  payment  to  be  made  July  i,  or  73/181  of  ^jniririn^ — 
which  is  $60.49.  The  cost  of  the  bonds  would  be  $5160.49.  If 
360  days  were  taken  as  the  year  and  the  half  year  taken  as  the 
unit,  since  one  half  of  the  annual  interest  is  paid  July  i,  then 
the  accrual  fraction  would  be  73/180  instead  of  73/181  and  the 
accrued  interest  $60.84.  If,  however,  the  month  be  taken  as 
the  unit  for  accruals  and  be  regarded  as  consisting  of  30  days, 
then  the  accrual  would  be  for  2-7/15  months  and  would  amount 
to  $61.00.  This  less  accurate  method  is  frequently  used  in  ac- 
cruals for  the  purpose  of  closing  the  books.  The  Xew  York 
Clearing  House  method  would  make  the  interest  $60.84  since 
360  days  is  treated  as  a  year  according  to  the  rules  of  the 
clearing  house.  According  to  the  statute  law  of  the  state  of 
New  York  the  accrued  interest  would  be  $60.49  because  365 
days  constitute  the  year  according  to  the  statute  in  question 
and  the  number  of  days  falling  in  each  half  year  is  taken  as 
you  find  it  except  that  the  extra  day  of  the  leap  year  is  ig- 


,    \ 


BOND  ACCOUNT  369 

nored.  We  may,  therefore,  assume  that  the  bonds  are  pur- 
chased at  $5160.49.    The  journal  entry  would  be  as  follows: 

Bond  Investments  5,100.00 

Bond  interest  60.49 

Cash  5,160.49 

On  July  I  the  corporation  would  receive  the  $150.00  of  interest 
for  the  half  year.  At  that  time  the  appropriate  journal  entry 
is  the  following: 

Cash  1 50.00 

Bond  Interest  150.00 

Entry  of  payment  of  semi-annual  interest 

The  $60.49  of  the  $150.00  received  by  the  corporation  was  in- 
terest income  for  the  seller  of  the  bond  and  not  for  the  buyer. 
The  seller  of  the  bond  held  as  an  investment  would  have  jour- 
nalized his  sale  as  follows: 

Cash  5,160.49 

Bond  Investment  5,100.00 

Bond  Interest  •  60.49 

If  the  issuing  corporation  sold  the  bonds  at  $102.00  and  ac- 
crued interest  it  would  journalize  the  sale  as  follows: 

Cash  5,160.49 

Unissued  Bonds  5,000.00 

Bond  Premium  100.00 

Bond  Interest  60.49 

When  a  bond  issue  is  placed  on  the  market  it  accumulates  in- 
terest, in  case  the  sale  materializes,  from  the  date  of  the  bond. 
In  case  the  sale  did  not  materialize  the  corporation  would  find 
no  good  reason  for  paying  interest  to  itself  on  unissued  bonds. 
If,  however,  a  corporation  invests  in  its  own  bonds  with  a  view 
to  accumulating  a  fund  for  some  purpose  by  setting  aside  the 
interest,  then  the  corporation  may  pay  itself  interest  on  its  own 
bonds. 

If  the  buyer  of  a  bond  were  strict  in  his  computation  he 
would  object  to  paying  what  is  described  above  as  accrued  in- 
terest in  addition  to  the  fair  investment  price  of  a  bond.  The 
accrued  interest  right  figured  at  $60.49  is  worth  a  little  less 


37©  ACCOUNTING  PRINCIPLES 

than  $60.49  because  about  two  and  one  half  months  elapse 
before  the  sum  is  received.  This  fact,  however,  seems  to  be 
largely  ignored  in  the  bond  market  and  this  right  to  receive 
$60.49  several  months  later  is  consequently  purchased  at  its 
face  value  instead  of  at  its  discounted  value. 

7.  Treasury  Bonds.  —  The  term  treasury  bonds  is  not 
limited  altogether  to  the  meaning  of  bonds  sold  and  later  re- 
purchased by  the  corporation.  It  is  also  applied  to  unissued 
bonds  either  certified  by  the  trustee  or  simply  authorized  under 
a  mortgage  or  other  written  instrument.  The  Interstate  Com- 
merce Commission  has  defined  as  nominally  issued  bonds  those 
which  have  been  certified  by  the  trustee  and  placed  with  the 
proper  officer  for  sale  and  delivery,  or  pledged,  or  placed  in 
some  fund  of  the  corporation.  If  bonds  which  have  been  is- 
sued and  outstanding  are  reacquired  by  the  corporation  they 
are  designated  by  the  Interstate  Commerce  Commission  as 
nominoMy  outstanding  bonds.  It  would  seem  desirable  to  re- 
tain for  the  treasury  bond  term  a  meaning  similar  to  that  ap- 
plied to  treasury  stock  if  usage  had  not  already  rendered  the 
term  ambiguous.  It  is  not  unusual  in  corporation  accounting 
to  include  the  nominally  outstanding  bonds  in  some  special  fund 
or  in  the  investment  bond  account.  From  the  standpoint  of 
their  availability  for  corporate  uses  there  are  the  following  four 
classes  of  bonds:  (a)  unissued  bonds,  or  those  authorized  and 
not  "nominally  issued";  (b)  those  nominally  issued;  (c)  those 
nominally  outstanding;  (d)  those  actually  outstanding,  or  those 
sold  to  a  bona  fide  purchaser  and  not  reacquired. 

There  must  always  exist  in  fact  a  liability  for  bonds  actually 
outstanding  which  cannot  exist  for  the  other  classes.  If  a  cor- 
poration became  insolvent  and  its  assets  are  sold  to  meet  the 
claims  of  the  creditors  none  of  the  tv-pes  of  bonds  except  actu- 
ally outstanding  bonds  would  have  a  claim  against  assets  which 
would  be  considered  by  the  owners  of  other  claims  against  assets. 
The  pledged  bonds  nominally  issued  might  become  actually 
outstanding  bonds  when  the  creditors  holding  them  as  security 
saw  fit  to  foreclose.  It  would  consequently  be  significant  to 
show  bonds  payable  in  the  balance  sheet  in  the  following  form: 


BOND  ACCOUNT  371 


Bonds  Payable 

Less: 

Unissued  Bonds 
Nominally  Issued  Bonds 
Nominally  Outstanding 
Bonds 


Bonds  Payable  Actually  Outstanding 


The  question  arises  as  to  how  the  nominally  outstanding 
bonds  should  be  entered  when  purchased.  This  question  is  in- 
volved in  the  nature  of  the  transaction.  A  candid  examination 
of  the  facts  must  require  the  conclusion  that  the  purchase  of  a 
corporation's  own  bonds  to  the  amount  of  $5000.00  decreases 
its  liabilities  by  the  same  amount,  but  does  not  increase  its  as- 
sets. If,  for  example,  the  bond  in  question  were  a  first  mort- 
gage bond  the  holder  of  a  second  mortgage  bond  would  be  in 
error  if  he  counted  the  $5000.00  of  nominally  outstanding  bonds 
as  a  liability  in  the  calculation  of  the  amount  of  liability  prior 
to  his  own.  If  the  assets  were  liquidated  and  the  corporation 
were  dissolved,  no  funds  would  be  required  to  meet  the  nomi- 
nally outstanding  bonds  which  had  been  purchased. 

If  the  corporation  purchased  back  at  par  $5000.00  of  bonds 
sold  at  102  and  accrued  interest  the  entry  would  be: 

Nominally  Outstanding  Bonds  5,000.00 

Cash  5,000.00 

Purchase  of  $5,000.00  of  company  bonds  at  par 

If  they  had  been  purchased  at  loi,  the  entry  would  be: 

Nominally  Outstanding  Bonds  5,000.00 

Premium  on  Bonds  50.00 

Cash  5,050.00 

Purchase  of  $5,000.00  of  company  bonds  at  loi 

By  this  transaction  the  corporation  lost  $50.00  of  the  premium 
secured  in  the  original  issue  of  the  bonds.  This  treatment  of 
the  account  of  nominally  outstanding  bonds  would  result  in  a 
correct  statement  of  the  liabilities  when  the  nominally  out- 
standing bonds,  the  nominally  issued  bonds,  and  the  unissued 


372  ACCOUNTING  PRINCIPLES 

bonds  are  subtracted  from  bonds  authorized  to  show  the  bond 
liability  of  the  corporation. 

The  same  principle  would  apply  to  the  entry  of  bonds  if 
purchased  at  a  discount.  The  account  would  be  charged  with 
the  par  of  the  bonds  and  bond  discount  would  be  credited  along 
with  the  cash  credits,  if  the  bonds  had  been  sold  at  a  discount. 
The  bond  premium  would  be  debited  if  the  bonds  had  been 
sold  at  a  premium.  The  treatment  of  the  purchase  of  com- 
pany bonds  and  the  treatment  of  reissued  bonds  as  deductions 
from  outstanding  liabilities  is  not  in  accord  with  more  gen- 
eral practice,  although  it  has  some  adherents.^ 

It  is  argued  by  some  that  the  purchase  of  company  bonds  for 
sinking  fund  purposes  makes  it  desirable  to  treat  such  bonds 
as  a  sinking  fund  investment  at  their  purchase  price  so  that  the 
sinking  fund  will  maintain  the  proper  proportions  when  com- 
pared with  the  bond  liability.  If,  however,  the  purchase  of 
company  bonds  be  regarded  as  decreasing  the  liability  of  the 
corporation  and  the  funds  used  be  regarded  as  a  credit  to  the 
sinking  fund,  the  sinking  fund  would  still  bear  the  right  pro- 
portion to  the  bonds  outstanding.  The  terms  of  a  deed  of  trust 
might  make  such  a  treatment  of  the  case  inadvisable,  but  there 
seems  to  be  no  fundamental  reason  why  the  deed  of  trust  should 
be  so  drawn  that  bonds  nominally  outstanding  would  be  neces- 
sarily treated  as  an  asset  when  purchased  with  funds  from  the 
sinking  fund. 

However,  when  company  bonds  are  carried  in  the  sinking 
fund  they  would  be  entered  as  any  other  bond  investment  so 
far  as  their  book  value  and  cost  are  concerned.  They  would 
be  entered  at  cost  and  their  premium  or  discount  would  be  duly 
authorized,  or  spread  over  the  life  of  the  bond  as  set  forth  in  a 
preceding  paragraph. 

In  case  it  was  found  desirable  to  use  the  term  "bonds  in  the 
treasury"  to  indicate  all  bonds  certified  by  the  trustee  and  held 
in  the  treasury  either  as  a  result  of  the  purchase  of  company 
bonds  or  as  a  result  of  delay  in  the  sale  of  certified  bonds,  the 
liabilities  of  the  corporation  would  be  correctly  represented  in 

'  See  C.  S.  Luddam,  C.  P.  A.  (N.  Y.),  Journal  of  Accountancy,  March,  1914. 


BOND  ACCOUNT  373 

the  balance  sheet  by  showing  this  class  of  bonds  along  with  the 
unissued  bonds  as  a  deduction  from  those  authorized.  The 
items  would  appear  as  follows: 


Bonds  Payable 
Less: 

Unissued  Bonds 

Bonds  in  the  Treasury 


Bonds  Payable  Outstanding  

In  case,  however,  one  desires  to  make  the  bond  classification 
fully  descriptive,  it  will  be  found  useful  to  adopt  the  Interstate 
Commerce  Commission's  classification.  The  classification,  at 
least,  serves  the  purpose  of  the  most  complete  analysis. 

PROBLEMS  AND    QUESTIONS 

I.  The  ABC  Corporation  is  incorporated  to  take  over  the  assets  and  the 
liabilities  of  the  AB  partnership  and  of  C's  individual  business.  The  AB 
partnership  has  assets  and  liabilities  as  follows: 

Assets 


Plant  and  Property 
Furniture  and  Fixtures 

$150,000.00 
20,000.00 

Merchandise  Inventory 
Cash 

75,000.00 
10,000.00 

$255,000.00 

Liabilities 

Notes  Payable 
Accounts  Payable 

$20,000.00 
50,000.00 

A's  Capital 
B's  Capital 

as  follows: 

100,000.00 
85,000.00 

C  has  assets  and  liabilities 

$185,000.00 

Plant  and  Property 
Delivery  Equipment 
Furniture  and  Fixtures 

Assets 

$85,000.00 
10,000.00 
15,000.00 

Merchandise  Inventory 
Cash 

50,000.00 
4,ooc.oo 

Liabilities 

$164,000.00 

Notes  Payable 
Accounts  Payable 

15,000.00 
35,000.00 

50,000.00 

C's  Capital 

$114,000.00 

374  ACCOUNTING  PRINCIPLES 

The  AB  partnership  is  allowed  for  goodwill  $25,000.00,  after  plant  and 
property  is  marked  down  $10,000.00.  C  is  allowed  a  goodwill  of  $12,000.00 
and  the  merchandise  inventory  is  reduced  by  $5,000.00. 

The  ABC  Corporation  authorized  $400,000.00  of  capital  stock  and  $100,- 
ooo.oo.of  first  mortgage  4J4  P^r  cent  bonds,  dated  January- 1, 1920,  and  due 
January  i,  1940.  with  interest  jjayable  annually  Januarj-  i.  The  bonds  are 
sold  on  a  5  per  cent  basis  to  the  Central  Trust  Co.  at  92.77  and  accrued 
interest,  one  half  in  cash  at  the  time  of  subscription  and  the  balance  in  6c 
days.  A,  B,  and  C  also  subscribe  for  $20,000.00  each  in  capital  stock,  pay- 
ing 10  per  cent  down,  the  balance  to  be  paid  in  equal  installments  in  three 
and  six  months  respectively. 

(a)  Make  journal  entries  to  transfer  the  partnership  to  the  corporation. 

(b)  Alake  journal  entries  to  transfer  C's  business  to  the  corporation. 

(c)  Make  the  opening  on  the  books  of  the  corporation. 

(d)  Make  journal  entries  also  covering  the  sale  of  the  bonds. 

(e)  Make  also  the  interest  entries  for  the  bonds  January  i,  1921,  when 
the  first  annual  interest  is  paid. 

2.  Define  the  various  classes  of  bonds  according  to  the  Interstate  Com- 
merce Conunission  classification. 

3.  (a)  On  .April  i  the  company  bought  for  cash  $5,000.00  of  5  per  cent 
bonds  on  a  6  per  cent  basis  at  90  and  accrued  interest.  The  bonds  were 
dated  January-  i,  1918,  the  interest  date  being  January-  i  and  July  i,  and 
the  purchase  was  made  in  the  state  of  New  York,  where  365  days  is  counted 
as  a  year.  Journalize  the  purchase,  designating  the  bonds  as  treasury 
bonds  purchased. 

(b)  On  September  i  the  bonds  are  sold  at  95  and  accrued  interest.  Jour- 
nalize. 


i 


CHAPTER  XXVIII 

CHANGES  IN  THE  VALUE  OF  THE  PROPRIETARY  INTEREST 
OF   THE   CORPORATION 

I.  Definition  of  Profits.  —  Much  has  been  written  by  ac- 
countants, economists,  and  others  about  profits  and  the  mean- 
ing of  the  term.  For  the  purposes  of  this  elementary  treatise 
the  term  net  profits  may  be  defined  as  the  earnings  of  the 
proprietary  interest  after  all  prior  contractual  payments  and 
accruals  have  been  duly  considered.  When  a  corporation  has 
been  first  organized  the  proprietary  interest  is  represented  by 
the  capital  stock.  The  additions  to  the  proprietary  interest 
from  year  to  year  are  credited  to  the  surplus  account  so  that 
the  proprietary  interest  of  a  corporation  which  has  been  in 
operation  for  a  period  of  time  is  represented  by  the  capital 
stock  plus  the  surplus.  The  periodic  additions  to  surplus  from 
year  to  year  represent  the  increases  in  the  proprietary  interest 
or  in  the  stockholders'  interest. 

The  increase  in  the  proprietary  interest  due  to  the  business 
operations  for  which  a  concern  is  organized  is  referred  to  as  the 
profits  from  operation.  There  are  also  sources  of  income  indi- 
recth^  associated  with  regular  operations  such  as  investments 
in  related  enterprises  or  incidental  rentals  and  earnings.  These 
incomes  are  generally  designated  as  other  income.  The  term 
net  profits  is  used  to  designate  the  balance  after  incidental  and 
interest  expense  deductions  are  made  from  the  total  income  re- 
sulting from  the  addition  of  other  income  to  profits  from  oper- 
ation. These  net  profits,  however,  generally  mean  the  ordinary 
net  profits.  Profits  from  the  sale  of  fixed  assets  or  any  extraor- 
dinary profit  are  frequently  carried  directly  to  the  surplus  ac- 
count. The  total  net  profits,  however,  would  include  the  ex- 
traordinary net  profits  and  hence  comprise  the  total  net  in- 
crease in  the  proprietary  interest. 

375 


376  ACCOUNTING  PRINCIPLES 

2.  Book  Value  of  Shares.  —  When  the  corporation  is  organ- 
ized the  shares  stand  on  the  books  at  the  par  value  and  there  is 
not  generally  any  surplus  reserve,  since  this  reserve  is  accumu- 
lated from  annual  profits.  Let  us  suppose  that  plant  and  prop- 
erty are  transferred  to  the  ABC  Corporation  at  $500,000.00, 
and  that  capital  stock  to  the  par  value  of  $500,000.00  is  issued 
to  the  owner  of  the  plant  and  property.  Let  us  further  sup>- 
p)ose  that  $500,000.00  additional  stock  is  sold  for  cash  at  par. 
The  balance  sheet  would  then  be  as  follows: 

ABC  Corporation 
Balance  Sheet,  December  31,  1920 

Assets  LiahUities 

Cash  $500,000.00     Capital  Stock  $1,000,000.00 

Plant  and  Property       500,000.00 


$1.000.000. 00  $1.000.000.00 

The  book  value  of  each  share  is  $100.00  in  the  begiiming. 
.\fter  a  year's  operation  the  net  profits  of,  say,  $50,000.00  are 
carried  to  surplus  and  the  balance  sheet  would  be  as  follows: 

ABC  Corporation 
Balance  Sheet,  December  31,  1921 

Assets  Liabilities 

Cash  $250,000.00     Capital  Stock           $1,000,000.00 

Accounts  Receivable  40,000.00     Surplus                            50,000.00 

Merchandise  Inv.  200,000.00 

Furniture  and  Fixts.  20,000.00 

Plant  and  Property  540,000.00 


$1.050.000.00  $1,050,000.00 

After  the  $50,000.00  of  profits  have  been  added  to  surplus  the 
total  proprietar}'^  interest  is  then  $1,050,000.00.  If  the  par 
value  of  a  share  is  $100.00  the  number  of  shares  would  be 
10,000  and  the  book  value  of  shares  on  December  31,  1921, 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      377 

would  be  $1,050,000.00  or  $105,00  per  share.  When  the  sur- 
plus had  accumulated  to  $500,000.00,  the  book  value  of  a  share 
would  be  $150.00. 

3.  Declaration  of  Dividends.  —  Instead  of  adding  the  net 
profits  of  each  year  to  surplus  there  may  be  a  distribution  from 
surplus  of  a  part  of  the  accumulated  earnings.  It  creates  a 
more  favorable  market  for  a  stock  if  a  dividend  of  a  certain 
amount  is  paid  each  year.  The  initial  dividend  should  not  be 
placed  so  high  that  it  will  probably  be  necessary  to  reduce  it 
in  later  years  in  order  to  preserve  the  surplus  accumulated  be- 
fore the  initial  dividend  is  declared.  The  market  value  of  the 
stock  is  favorably  affected  by  a  stable  dividend  or,  at  least, 
one  that  is  not  decreased  from  year  to  year.  It  is  common, 
therefore,  for  a  corporation,  in  prosperous  years,  to  declare  an 
increased  dividend  as  an  "extra  dividend.  If  the  regular  divi- 
dend is  6  per  cent  and  it  seems  feasible  for  a  particular  year  to 
declare  an  8  per  cent  dividend,  the  declaration  may  take  the 
form  of  a  regular  dividend  of  6  per  cent  and  an  extra  dividend 
of  2  per  cent.  The  regular  dividend  would  not  be  made  8  per 
cent  until  it  seemed  probable  that  the  annual  dividends  of  the 
future  would  not  fall  below  8  per  cent.  The  payment  of  divi- 
dends makes  it  necessary  to  have  a  list  of  stockholders  with 
addresses.  When  stocks  are  sold  they  must,  therefore,  be  re- 
corded in  the  books  of  the  treasurer  as  transferred.  A  trans- 
fer book  is  frequently  used  for  this  purpose;  the  shareholder 
who  sells  his  shares  would  be  charged  in  his  capital  stock  ac- 
count for  the  par  value  of  the  shares  sold  and  the  purchaser 
would  be  credited  in  the  capital  stock  ledger  for  the  par  value 
of  the  shares  purchased.  The  capital  ledger,  therefore,  will  fur- 
nish the  list  of  stockholders  which  will  suffice  for  the  payment 
of  dividends. 

The  dividends  are  declared  as  payable  to  the  shareholders  of 
record  as  of  a  certain  date  and  are  also  declared  as  payable  a 
few  days  after  this  date  of  closing  the  transfer  books  for  the 
purpose  of  making  a  list  of  stockholders.  Suppose  a  2  per  cent 
dividend  were  declared  as  payable  January  15,  1922,  to  stock- 
holders of  record  January  i,  1922.    Books  might  then  be  closed 


378  ACCOUNTIXG  PRINCIPLES 

for  transfer  purposes  from  January  i,  1922,  to  January  15,  1922. 
The  stocks  sold  between  January  i  and  January  15  would  be 
sold  ex-dividend.  If  the  dividend  were  6  per  cent  the  market 
value  of  the  share  on  Januar\'  i  should  decrease  S6.00  per 
share.  If  a  share  were  purchased  Januar>'  2  the  seller  would 
receive  the  dividend  of  Januar\'  15,  although  he  might  not  own 
the  share  at  that  time.  The  buyer  takes  the  share  ex-divi- 
dend, which  means  that  he  will  not  receive  the  approaching 
dividend. 

4.  Journal  Entry  of  Dividends.  —  If  a  2.  per  cent  dividend 
were  declared  December  15,  1921,  payable  Januar>'  12,  1922, 
on  the  $1,000,000.00  of  stock  the  joimial  entrj-  wovdd  be  as  fol- 
lows: 

December  15,  1921 

Surplus-Dividend  10,000.00 

Dividend  Payable  10,000.00 

Declaration  of  dividend  on  common  stock 

WTien  the  dividend  was  paid  the  entr\'  would  be: 

January  15,  1922 

Dividend  Payable  10,000.00 

Cash  10,000.00 

Pa>'ment  of  2  per  cent  di\'idend 

5.  Dividends  and  Book  Value.  —  The  surplus  has  been  re- 
duced $10,000.00  by  the  dividend  and  the  total  book  value  of 
the  proprietary  interest  has  been  reduced  from  $1,050,000.00  to 
$1,030,000.00,  the  book  value  per  share  being  reduced  from 
$105.00  to  $103.00. 

6.  Book  Value  and  Market  Value.  —  The  book  value  of 
shares  signifies  what  has  been  invested  by  the  proprietary  in- 
terest rather  than  the  present  sale  price  of  this  investment.  The 
annual  total  net  profits  of  a  corporation  divided  by  the  num- 
ber of  shares  represents  the  annual  earnings  of  each  share.  The 
market  value  of  a  share  depends  more  on  its  prospective  annual 
earnings  than  on  the  book  value.  An  increase  in  book  value 
has  a  significance  because  it  is  fair  to  presume  that  the  in- 
creased investment  per  share  will  result  in  increased  earnings 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      379 

per  share.  If  the  prevailing  rate  of  interest  which  investors 
may  expect  on  an  investment  of  the  character  of  the  ABC  Cor- 
poration stock  were  8  per  cent  and  the  annual  earnings  amount 
to  only  5  per  cent  on  the  par  of  the  stock  or  S5.C0  per  share,  then 
the  shares  would  sell  for  $5,001.08  or  $62.50  per  share.  The 
rate  of  capitalization  in  this  case  is  8  per  cent.  There  are  va- 
rious factors  affecting  this  rate,  such  as  the  risk  involved  and 
the  policy  as  to  dividend  distribution.  For  good  investments 
(those  involving  little  risk)  the  rate  is  lower  and  the  value  of  a 
given  prospective  annual  earning  is  greater.  It  is  clear  that 
anything  affecting  the  expected  earnings  of  a  corporation  will 
also  affect  the  market  value  of  its  shares. 

7.  Stock  Dividends.  —  The  stock  dividend  accomplishes  for 
the  stockholders  of  the  corporation  substantially  the  same  thing 
that  the  credit  to  capital  accomplishes  in  the  case  of  the  part- 
nership. It  is  a  device  by  which  the  surplus  of  the  corporation 
is  carried  to  the  credit  of  the  stockholders  in  the  form  of  a  cer- 
tain number  of  shares  with  a  definite  par  value.  A  stock  divi- 
dend is  never  declared  unless  there  is  a  corporate  surplus  ac- 
cumulated to  offset  the  stock  dividend.  Let  us  suppose  that 
the  ABC  Corporation  after  accumulating  a  surplus  of  $500,- 
000.00  decides  to  issue  a  stock  dividend  of  25  per  cent.  This 
stock  dividend  would  carry  to  each  shareholder  with  four 
shares  an  additional  share,  making  his  interest  to  consist  of 
five  shares  in  the  corporation  instead  of  four.  However,  the 
aggregate  proprietary  interest  consisting  of  capital  stock  plus 
surplus  is  not  affected  by  the  stock  dividend.  Part  of  the  pro- 
prietary interest  which  was  formerly  classified  as  surplus  is, 
after  the  declaration  of  the  stock  dividend,  classified  as  capital. 
The  journal  entry  for  the  declaration  of  the  25  per  cent  divi- 
dend would  be  as  follows: 

Surplus-Stock  Dividend  250,000.00 

Dividend  Payable  250,000.00 

The  dividend  would  again  be  declared  payable  on  a  certain 
date  to  stockholders  of  record  on  a  prior  date.  The  payment 
of  the  dividend  would  be  accomplished  by  the  issue  of  250 


38o  ACCOUNTING  PRINCIPLES 

shares  which  would  be  distributed  as  a  25  per  cent  dividend  on 
the  holdings  of  each  shareholder  in  the  corporation.  Some  of 
the  shareholders  would  receive  fractional  shares,  since  25  per 
cent  of  their  holdings  would  not  represent  an  integral  number 
of  shares.  WTien  the  dividend  is  paid  the  journal  entry  would 
be  as  follows: 

Dividend  Payable  250,000.00 

Capital  Stock  250,000.00 

The  specific  shareholders'  accounts  in  the  stock  ledger  would  be 
credited  with  the  additional  shares  going  to  each  shareholder 
as  a  result  of  the  declaration  of  the  stock  dividend. 

The  Supreme  Court  has  recently  held  that  a  stock  dividend 
is  not  income.  The  only  peculiarity  about  the  question  is  that 
a  stock  dividend  should  have  ever  been  supposed  to  constitute 
income.  It  is  clear  that  the  shareholders  and  the  corporation 
itself  own  no  more  after  the  declaration  of  dividends  than  they 
owned  before  the  declaration.  The  ownership  of  shares  carried 
with  it  the  ownership  of  the  surplus  and  the  distribution  of 
additional  shares  did  not  increase  the  total  equity  or  the  total 
book  value  of  interest  in  the  assets  of  the  corporation.  An  in- 
come to  the  shareholders  from  the  corporation  always  results  in 
a  decrease  in  the  assets  of  the  corporation. 

8.  Subscription  Rights.  —  Frequently  the  shareholders  of  a 
corporation  decide  to  increase  the  capital  stock  by  issuing  an 
additional  nmnber  of  shares  to  be  paid  for  at  the  par  yalue. 
If,  however,  the  shares  have  a  market  value  in  excess  of  par, 
as  a  result  of  the  accumulation  of  the  surplus,  the  new  shares 
issued  will  ordinarily  sell  for  more  than  their  par  value  after 
they  have  been  subscribed  for  and  issued  to  the  stockholders. 
As  a  result  of  this  fact,  the  stockholders  ordinarily  reserve  for 
themselves  the  right  to  purchase  the  new  shares,  each  share- 
holder having  the  right  to  purchase  an  amount  of  the  new 
shares  in  proportion  to  his  holdings  at  the  time  of  the  issue.  If 
the  capital  stock  were  increased  25  per  cent,  each  shareholder 
would  be  entitled  to  subscribe  for  additional  shares  in  an  amount 
equal  to  25  per  cent  of  the  number  of  shares  already  OMmed 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      38 1 

by  the  stockholder.  A  stockholder  owning  four  shares  would 
have  the  right  to  subscribe  for  the  additional  share  which  he  is 
entitled  to  purchase.  He  would,  however,  have  the  alternative 
of  selling  his  right  at  its  market  value  on  the  open  market. 
Let  us  now  see  what  the  value  of  a  right  to  subscribe  would 
be.  Suppose,  for  example,  the  market  value  of  the  shares  of  a 
corporation  is  $150.00  per  share.  Four  of  such  shares  would  be 
worth  $600.00.  One  additional  share  at  $100.00  would  mean 
that  the  assets  back  of  the  five  shares  including  the  additional 
one  issued  would  be  worth  $700.00  and  consequently  the  value 
of  the  assets  corresponding  to  each  share  would  be  700/5  or 
$140.00.  In  other  words,  by  paying  $100.00  a  man  with  four 
shares  acquires  an  additional  share  worth  $140.00.  The  profit 
on  the  transaction  is  clearly  $40.00.  The  subscription  right, 
therefore,  going  with  each  one  of  the  four  shares  would  be 
worth  one  fourth  of  the  $40.00,  or  $10.00  per  share.  In  such 
an  instance,  rights  would  sell  at  approximately  $10.00  per 
share  held  prior  to  the  new  issue.  The  actual  market  value  of 
the  rights  may  vary  to  some  extent  from  the  calculated  value 
of  the  right  to  subscribe,  on  account  of  the  particular  circum- 
stances affecting  the  demand  for  the  stock  in  question,  but  in 
general  the  market  value  will  not  fluctuate  widely  from  the 
calculated  value  of  the  right  as  indicated  above.  The  journal 
entry  involved  in  the  issue  of  additional  stock  does  not  differ 
from  the  entries  already  described  in  connection  with  opening 
the  books  of  the  corporation. 

9.  Discount  on  Stock.  —  While  most  of  the  states  require 
that  all  capital  stock  shall  be  issued  for  property  worth  not  less 
than  the  par  value  of  the  stock  issued,  there  is  still  a  possibil- 
ity in  some  parts  of  the  country  and  in  other  countries,  of  is- 
suing shares  for  an  amount  of  cash  less  than  the  par  value  of 
the  shares  in  question.  If  $250,000.00  of  capital  stock  is  issued 
at  seventy-five  cents  on  the  dollar,  the  entry  would  be  as  fol- 
lows: 

Cash  187,500.00 

Discount  on  Stock  62,500.00 

Capital  Stock  250,000.00 


382  ACCOUNTING   PRINCIPLES 

This  discount  of  $62,500.00  represents  in  fact  that  the  proprie- 
tary interest  when  stated  at  $250,000.00  is  overstated  by  $62,- 
500.00.  This  overstatement  may  be  remedied  by  crediting  each 
year  a  certain  portion  of  the  corporate  surplus  to  discount  on 
stock.  Let  us  suppose,  for  example,  that  it  was  decided  to 
mark  off  the  $62,500.00  of  discount  on  stock  over  a  period  of 
ten  years.  Each  year  $6,250.00  of  the  discount  would  be 
charged  against  the  surplus,  the  journal  entry  being  as  follows: 

Surplus  6,25o.cx» 

Discount  on  Stock  6,2  5o.cxj 

Charging  discount  on  stock  to  surplus 

At  the  end  of  ten  years  the  discount  on  stock  would  have  dis- 
appeared, and  the  capital  stock  liability  would  fairly  represent 
the  actual  investment  of  the  stockholders  in  the  corporation. 
At  any  time  prior  to  this,  the  proprietary  investment  would 
be  fairly  represented  on  the  liability  side  of  the  balance  sheet 
by  the  deduction  of  the  discount  on  stock  from  the  capital 
stock  issued.  For  example,  at  the  end  of  the  first  year,  when 
$6,250.00  of  the  $62,500.00  had  been  charged  against  surplus, 
the  following  statement  of  the  capital  stock  item  would  fairly 
represent  the  proprietary  capital  investment : 

Capital  Stock  $250,000.00 

Less:  Discount  on  Capital  Stock      56,250.00 


Capital  Stock  Investment  $193,750.00 

This  manner  of  statement,  however,  is  not  one  generally 
adopted,  although  it  would  be  the  most  desirable  statement  of 
fact.  In  some  instances  the  discount  on  stock  may  be  car- 
ried on  the  asset  side  of  the  balance  sheet,  where  it  would 
serve  to  convey  the  idea  of  an  amount  of  assets  in  excess  of  a 
fair  statement  of  the  total  investment  in  these  assets.  There 
are  some  who  have  argued  that  a  discount  on  stock  is  a  part  of 
the  cost  of  the  property  actually  turned  over  in  exchange  for 
the  stocks.  This,  however,  seems  to  be  a  superficial  view  of 
the  nature  of  the  transaction  involved. 

10.   Premium  on  Stock.  —  It  is  much  more  common,  how- 
ever, to  have  stock  issued  in  the  first  instance  for  cash  in  ex- 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      ^8^ 

cess  of  the  par  value  of  the  shares  than  it  is  to  receive  an 
amount  of  cash  less  than  the  par  value  of  the  stocks  issued. 
Property  is  frequently  overvalued  in  connection  with  the  issue 
of  stock.  However,  when  shares  are  issued  for  cash  in  connec- 
tion with  an  original  issue  they  are  more  commonly  sold  at  the 
par  value  of  the  shares.  The  national  banks  frequently  sell 
shares  in  excess  of  par,  because  the  law  requires  the  bank  to 
accumulate  a  certain  surplus  prior  to  the  declaration  of  the 
dividends.  If,  however,  the  required  surplus  is  contributed  by 
the  shareholders  in  connection  v/ith  the  organization  of  the 
corporation,  there  will  be  no  legal  prohibition  against  the  pay- 
ment of  dividends  even  during  the  first  year  of  the  operation  of 
a  bank.  If  $200,000.00  of  capital  stock  is  sold  at  120,  the  jour- 
nal entry  would  be: 

Cash  120,000.00 

Capital  Stock  100,000.00 

Premium  on  Stock  20,000.00 

Sale  of  $100,000.00  of  capital  stock  at  premium  of  20 
per  cent. 

The  national  banks,  however,  generally  credit  the  $20,000.00 
to  surplus  instead  of  designating  the  item  as  premium  on  capi- 
tal stock.  It  seems  desirable,  however,  that  the  word  "sur- 
plus" be  used  to  describe  the  increases  in  proprietary  interest 
from  year  to  year  arising  from  the  operations  of  the  business 
rather  than  from  initial  investment.  It  is  of  course  true  that 
the  premium  on  stock  is  a  part  of  the  proprietary  investment 
just  as  the  surplus  is  a  part  of  the  proprietary  investment,  and 
should  be  added  in  with  surplus  in  connection  with  the  calcu- 
lation of  book  value  of  the  shares  of  the  corporation.  There  is 
no  occasion  for  the  retiring  of  premium  on  stock.  It  is  re- 
garded as  appropriate  that  the  dividends  shall  be  declared  out 
of  surplus  accumulated  from  the  earnings  of  operation.  The 
contributed  surplus,  such  as  that  arising  from  premium  on 
stock,  is  ordinarily  regarded  as  a  part  of  the  permanent  pro- 
prietary interest  of  the  stockholders  rather  than  as  a  part  of 
the  surplus  subject  to  distribution  from  time  to  time. 


384  ACCOUNTING  PRINCIPLES 

II.  Available  Surplus.  —  The  term  available  surplus  is  or- 
dinarily understood  to  designate  that  part  of  the  surplus  of 
a  corporation  which  is  available  for  dividends.  There  is  no 
legal  objection  to  the  distribution  of  the  entire  accumulated 
surplus  of  a  corporation.  There  would  be  no  legal  bar  to  a 
declaration  of  dividends  from  premium  on  stock,  if  this  divi- 
dend did  not  reduce  the  surplus  to  an  amount  below  that  which 
might  be  required  by  law  as  in  the  case  of  the  national  banks. 
It  is  not  regarded,  however,  as  desirable  business  procedure  to 
distribute  to  stockholders  except  from  the  surplus  which  has 
been  accumulated  from  earnings.  All  of  this  surplus  would  be 
commonly  regarded  as  available  for  the  distribution  of  cash 
dividends  or  stock  dividends.  If  one  should  define  available 
surplus  with  reference  to  the  amount  of  such  surplus  which 
would  be  available  for  cash  dividends,  it  would  be  necessary  to 
reduce  further  the  amount  of  surplus  which  could  be  regarded 
as  available.  Cash  cannot  be  distributed  in  excess  of  that 
which  is  on  hand.  If  the  cash  on  hand  were  less  than  the  ac- 
cumulated surplus  then  the  surplus  available  for  cash  dividends 
would  be  less  than  the  accumulated  surplus.  In  some  instances 
the  corporation  may  borrow  money  for  the  purpose  of  declar- 
ing cash  dividends,  provided  there  is  an  available  surplus  out 
of  which  dividends  can  be  properly  declared.  This  type  of 
loan,  however,  is  unusual,  and  is  not  generally  regarded  as  con- 
servative business  practice.  If  cash  were  temporarily  tied  up 
in  current  assets  soon  to  be  realized,  it  might  be  regarded  as 
legitimate  to  make  a  temporary'  loan  for  the  purpose  of  the 
payment  of  the  dividend.  The  funds  to  be  distributed  to  stock- 
holders as  a  dividend  might  be  secured  from  bank  loans  or  by 
the  issuance  of  bonds  or  notes.  This  is  a  procedure  which  does 
not  reflect  credit  on  the  financial  management  of  a  corpora- 
tion. 

There  is  in  the  case  of  some  corporations  a  term  more  con- 
venient than  surplus  for  indicating  the  accumulated  earnings 
which  are  not  regarded  as  a  part  of  the  permanent  proprietary 
investment.  This  term  is  the  undivided  profits  of  the  corpora- 
tion.   In  many  bank  statements  the  term  undivided  profits  will 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      385 

be  found.  Dividends  01  banks  would,  in  general,  be  declared 
out  of  the  undivided  profits  of  the  bank.  When  earnings  are 
carried  from  the  undivided  profits  into  surplus,  it  is  recognized 
that  they  become  a  part  of  the  permanent  proprietary  invest- 
ment of  the  corporation  and  they  would  not,  in  general,  be  dis- 
tributed to  stockholders  unless  they  were  later  covered  by  a 
stock  dividend.  This  stock  dividend,  however,  is  not  in  fact  a 
distribution,  and  simply  represents  a  different  name  or  form 
for  the  proprietary  investment.  The  undivided  profits  term 
would  seem  to  be  an  entirely  desirable  form  of  designating  the 
accumulated  earnings  which  have  not  been  so  tied  up  in  fixed 
assets  or  some  other  form  of  permanent  investment  that  they 
would  not  be  available  for  the  declaration  of  cash  dividends. 
Surplus  would  come  to  mean  that  part  of  the  accumulated 
earnings  of  the  property  which  has  been  used  for  the  perma- 
nent enlargement  of  the  enterprise  of  the  stockholders,  but  has 
not  been  covered  by  issues  of  additional  stock  in  the  form  of 
stock  dividends. 

12.  Appropriated  Surplus.  —  The  words  appropriated  surplus 
are  commonly  used  to  designate  that  part  of  the  corporate  sur- 
plus which  has  been  set  aside  for  some  special  use.  For  exam- 
ple, if  the  corporation  surplus  amounted  to  $200,000.00  and 
$100,000.00  of  this  corporate  surplus  were  set  aside  for  prop- 
erty additions  or  for  improvements,  the  journal  entry  would 
be  as  follows: 

Surplus  100,000.00 

Appropriated  Surplus-Improvements  100,000.00 

Instead  of  having  all  of  the  appropriated  surplus  items  in  one 
account  it  might  be  desirable  to  carry  several  accounts  repre- 
senting the  purposes  of  the  appropriations.  In  such  cases  the 
appropriated  surplus  item  may  be  designated  as  a  reserve.  The 
alternative  entry  would  then  be: 

Surplus  100,000.00 

Reserve  for  Improvements  100,000.00 

Setting  aside  part  of  surplus  for  improvements 


386  ACCOUNTING  PRINCIPLES 

The  words  appropriated  surplus  might  then  be  used  as  the 
name  of  an  item  in  the  balance  sheet  under  which  the  several 
special  reserves  would  be  listed.  For  example,  if  these  reserves 
in  the  case  of  a  given  corporation  were  for  improvements  or  for 
a  sinking  fund,  they  might  be  designated  on  the  balance  sheet 
as  follows: 

Appropriated  Surplus: 

Sinking  Fund  Reserve  $25,ooo.cx3 

Reserve  for  Improvements     50.000.00  75,000.00 

The  two  accounts  involved  would  be  the  sinking  fund  reserve 
and  the  reserve  for  improvements.  The  appropriated  surplus 
would  simply  be  the  name  of  a  group  of  accounts  brought  to- 
gether in  the  balance  sheet  because  of  their  similarity. 

13.  Donated  Stock.  —  According  to  the  laws  of  most  of  the 
states  it  is  illegal  to  issue  shares  of  stock  with  a  par  value  in 
excess  of  the  value  of  property  transferred  to  the  corporation 
in  exchange  for  the  shares.  However,  there  is  no  efficient  ad- 
ministrative provision  in  many  of  these  states  for  the  enforce- 
ment of  the  statute.  Property  is  frequently  transferred  to  the 
corporation  in  exchange  for  shares  with  a  par  value  far  in  ex- 
cess of  the  market  value  of  the  property  received  by  the  corpo- 
ration. A  group  of  individuals  in  organizing  a  corporation  can 
transfer  to  the  corporation  a  certain  amount  of  property  in  ex- 
change for  the  total  amount  of  authorized  capital.  The  capital 
thus  becomes  paid  up  stock.  The  shareholders  can,  if  they  see 
fit,  donate  to  the  corporation  25  or  50  per  cent  of  the  capital 
stock  or  such  other  amounts  as  they  may  determine,  and  the 
corporation  will  then  have  the  right  to  issue  this  paid  up  capi- 
tal to  subscribers  for  treasury  stock  at  such  prices  as  the  shares 
may  bring  on  the  open  market.  This  procedure  amounts  in 
fact  to  an  evasion  of  the  law  in  regard  to  the  issue  of  shares  in 
exchange  for  property  worth  less  than  the  par  value  of  the 
shares  issued.  Let  us  suppose  that  X,  Y,  and  Z  organize  a  cor- 
poration and  turn  over  their  property  to  the  corporation  in 
exchange  for  capital  stock  with  a  par  value  of  $500,000.00. 
They  then  decide  to  raise  working  capital  by  donating  to  the 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST     387 

corporation  25  per  cent  of  their  respective  holdings,  to  be  later 
sold  for  the  purpose  of  raising  working  capital.  The  journal 
entry  involved  in  donating  this  stock  to  the  corporation  would 
be: 

Treasury  Stock  i25,oc».oo 

Donated  Surplus  125,000.00 

Donation  of  trea.="ry  stock  by  stockholders 

If  the  stock  were  donated  with  the  specific  provision  that  it 
should  be  used  for  working  capital  the  account  working  capital 
might  be  substituted  in  the  journal  entry  for  the  term  donated 
surplus.  It  is  also  a  general  practice  to  regard  the  treasury 
stock  as  one  of  the  assets  of  the  corporation  and  donated  sur- 
plus as  one  of  the  surplus  reserves  of  the  corporation.  It  is 
questionable  whether  in  fact  treasury  stock  can  be  fairly  re- 
garded as  an  asset  of  the  corporation  because  of  the  fact  that 
the  corporation  cannot  own  a  proprietary  claim  in  its  own  as- 
sets; that  is,  the  corporation  owns  all  of  the  assets  and  it  owes 
the  stockholders  and  the  holders  of  liabilities  for  what  it  has 
received  in  the  form  of  assets.  If  any  claim,  whether  of  the 
character  of  a  bond  or  stock,  is  turned  over  to  the  corporation, 
its  liabilities  to  the  bondholders  or  to  the  stockholders  would 
thereby  be  canceled.  If  no  money  were  paid  in  exchange  for 
the  bond  or  stock,  the  surplus  would  be  increased  by  the  par 
value  of  the  donated  liability  or  proprietary  interest.  The 
actual  proprietary  investment  would  therefore  be  properly 
represented  on  the  balance  sheet  by  making  treasury  stock  a 
deduction  from  capital  stock  issued,  the  balance  being  desig- 
nated as  outstanding  capital  stock.  In  the  instance  above 
cited,  let  us  assume  that  the  balance  sheet  stood  as  follows 
prior  to  the  donation  of  the  stock: 


Balance  Sheet,  XYZ  Corporation 


Assets 
ant  and 
Property         $500,000.00 

Liabilities 
Capital  Stock  $500,000.00 

388  ACCOUXnXG  PRINXIPLES 

After  the  donation  of  $125,000.00  of  stock,  the  balance  sheet 
might  be  properly  represented  as  follows: 

Balance  Sheet,  XYZ  Corporation 

Assets  Liabilities 

Plant  and  Capital  Stock  $500,000.00 

Property         $500,000.00    Less: 

Treas.  Stock  125,000.00 


Outstanding  Capital  Stock    375,000.00 
Donated  Surplus  125,000.00 


$500,000.00  $500,000.00 


This  type  of  representation  does  not  correspond  to  universal 
usage.  Frequently  treasury  stock  is  carried  in  the  balance 
sheet  as  an  asset  of  the  corporation.  If  the  $125,000.00  of 
treasury  stock  were  sold  for  $100,000.00  cash,  the  journal  entry 
would  be: 

Cash  100,000.00 

Discoxmt  on  Treasury  Stock      25,000.00 

Treasury  Stock  125,000.00 

Sale  of  the  corporation's  treasury  stock 

At  the  time  of  closing  the  books,  the  discount  on  treasury  stock 
account  should  be  closed  into  the  donated  surplus  account  by 
the  following  journal  entry: 

Donated  Surplus  25,000.00 

Discoimt  on  Treasury  Stock  25,000.00 

Closing  discount  on  treasury  stock  into  donated  sur- 
plus 

14.  Purchase  of  Treasury  Stock.  —  WTiile  it  is  not  generally 
regarded  as  legitimate  practice  for  a  corporation  to  deal  in  its 
own  capital  stock,  it  frequently  happens,  nevertheless,  that  a 
corporation  does  purchase  its  own  stock.  This  would  be  re- 
garded as  entirely  legitimate,  if  it  were  under  obligations  to  re- 
tire the  stock  at  a  certain  designated  time.  The  stock  might 
then  be  retired  by  purchase  in  advance  of  the  date  when  its  re- 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      389 

tirement  might  be  required.  If  the  XYZ  Corporation  should 
purchase  $20,000.00  of  its  outstanding  stock  at  $90.00  per  share, 
the  following  entry  might  be  made  covering  the  purchase: 

Treasury  Stock  20,000.00 

Discount  on  Treasury  Stock  2,000.00 

Cash  18,000.00 

Purchase  of  $20,000.00  of  treasury  stock 

This  form  of  entry  would  be  more  in  accord  with  the  donated 
stock  entry  described  above.  However,  practice  is  not  entirely 
imiform  in  regard  to  the  entry  of  donated  stock.  There  are 
some  who  regard  treasury  stock  as  an  asset,  and  would  there- 
fore be  inclined  to  enter  donated  stock  at  the  estimated  market 
value  of  the  stock  donated,  and  to  credit  donated  surplus  with 
a  similar  amount.  Likewise,  they  would  enter  the  purchase  of 
the  $20,000.00  of  capital  stock  referred  to  above  as  follows: 

Treasury  Stock  18,000.00 

Cash  18,000.00 

Purchase  of  $20,000.00  of  stock  at  90 

This  latter  entry  would  require  that  treasury  stock  be  carried  as 
an  asset  of  the  corporation  while  the  former  entry  would  require 
that  the  $20,000.00  of  treasury  stock  be  carried  as  a  deduction 
from  capital  stock  issued,  and  would  further  require  that  the 
discount  on  treasury  stock  of  $2,000.00  should  be  closed  into 
the  surplus  account  at  thfe  time  of  closing  the  books.  The  lat- 
ter usage  seems  to  the  writer  to  be  more  in  accord  with  the 
facts  and  with  the  nature  of  the  transaction  involved.  The 
fact  is  that  treasury  stock  once  purchased  is  canceled  and  ad- 
ditional shares  are  issued  when  a  sale  is  made  of  an  amount  of 
stock  equal  to  that  which  has  been  purchased.  So  far  as  the 
nature  of  the  asset  is  concerned,  there  seems  to  be  little  differ- 
ence between  stock  duly  certified  and  ready  to  issue  and  stock 
which  has  been  purchased  subject  to  re-issue  by  the  corpora- 
tion. In  both  cases  there  is  a  decrease  of  the  proprietary  in- 
vestment in  the  form  of  capital  stock  as  compared  with  the 
authorized  capital. 
If  $10,000.00  of  the  $20,000.00  of  capital  stock  purchased 


30O  ACCOUNTING   PRINCIPLES 

above  were  sold  at  $95.00,  the  journal  entry  involved  would  be 
as  follows: 

Cash  9,500.00 

Discount  on  Treasury  Stock  500.00 

Treasury  Stock  10,000.00 

If,  however,  treasury  stock  were  regarded  as  an  asset  at  $18,- 
000.00,  then  the  sale  of  $10,000.00  of  stock  costing  $9,000.00 
at  $9,500.00  would  be  journalized  as  follows: 

Cash  9,500.00 

Treasury  Stock  9,000.00 

Surplus  500.00 

Sale  of  $10,000.00  of  treasury  stock  costing  $9,000.00 
for  $9,500.00 

A  question  might  be  raised  as  to  whether  a  profit  on  treasury 
stock  should  be  carried  directly  to  surplus.  It  might  be  argued 
that  the  surplus  should  be  specifically  designated  so  as  to  dif- 
ferentiate it  from  the  regular  surplus  of  the  corporation.  In 
general,  however,  the  profit  would  probably  be  carried  directly 
to  surplus.  The  writer  does  not  believe  that  the  latter  entry 
represents  the  best  practice  because  treasury  stock  is  not  be- 
lieved to  be  properly  regarded  as  an  asset  of  the  corporation. 

15.  Sale  of  Fixed  Assets.  —  There  is  a  distinct  advantage 
in  showing  the  net  profits  item  of  the  corporation  from  year  to 
year  in  such  form  that  it  will  be  fairly  comparable  with  the 
net  profits  of  other  years.  This  has  ordinarily  been  accom- 
plished in  accounting  by  making  the  net  profits  revealed  by  the 
revenue  statement  to  consist  of  the  profits  of  operation  plus  the 
incidental  profits  derived  from  incidental  investments  of  the 
business.  Profits  from  the  sale  of  fixed  assets  have  then  been 
generally  closed  directly  into  surplus  without  being  shown  in 
the  regular  revenue  statement  in  the  comparison  of  the  prog- 
ress of  a  business  from  year  to  year.  However,  there  is  also 
something  to  be  said  in  favor  of  bringing  the  surplus  account 
into  the  regular  statement  and  showing  the  sources  of  addi- 
tions to  surplus  that  may  arise  out  of  extraordinary  circimi- 
stances  such  as  the  sale  of  fixed  assets. 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      391 

16.  Surplus  Account.  —  At  the  beginning  of  each  year  the 
credit  balance  of  the  surplus  account  represents  the  accumu- 
lated earnings  and  profits  from  all  sources  which  have  not 
been  distributed  in  previous  years,  or  appropriated  for  the 
purpose  of  being  used  for  certain  designated  purposes.  At 
the  close  of  the  year  the  balance  of  the  profit  and  loss  account 
is  carried  to  the  credit  of  the  surplus  account.  Dividends  de- 
clared are  debited  to  the  surplus  account.  Likewise,  separate 
surplus  accounts  are  frequently  created  for  such  portions  of 
surplus  as  may  be  designated  as  usable  only  for  specific  pur- 
poses. Corrections  in  the  surplus  account  as  at  the  beginning 
of  the  year,  arising  out  of  the  discovery  of  errors  in  the  ac- 
counts of  a  preceding  year,  would  be  carried  as  debits  or  cred- 
its to  the  surplus  account  at  the  end  of  the  succeeding  year. 
If  several  adjustments  are  made  in  the  surplus  account,  an  ad- 
justment account  is  sometimes  set  up,  and  the  balance  of  this 
account  is  carried  to  the  surplus  account.  For  example,  let  us 
suppose  that  the  valuation  of  furniture  and  fixtures  is  to  be 
decreased  by  $750.00,  th.e  valuation  of  buildings  to  be  de- 
creased by  $3,000.00,  and  the  reserve  for  bad  debts  is  to  be 
corrected  by  carrying  $1500.00  of  its  balance  to  the  credit  of 
the  surplus  account.  The  following  journal  entries  might  be 
made  to  represent  these  changes: 


Adjustment  Account 
Furniture  and  Fixtures 
Buildings 

3,750-00 

750.00 
3,000.00 

Reserve  for  Bad  Debts 
Adjustments 

1,500.00 

1,500.00 

Surplus 
Adjustments 

2,250.00 

2,250.00 

This  series  of  entries  would  serve  to  bring  all  of  the  adjusted 
items  to  the  surplus  account  as  one  total  instead  of  carrying 
them  to  the  surplus  account  as  separate  items.  However,  the 
adjustment  account  has  less  use  in  corporation  accounting  than 
in  the  accounting  for  partnerships.  Each  change  in  the  value 
of  assets  would  involve  for  the  partnership  a  distribution  to 


392  ACCOUNTING  PRINCIPLES 

the  several  capital  accounts.  The  work  is  therefore  very  much 
shortened  by  the  use  of  the  adjustment  accounts,  thus  avoid- 
ing all  the  distributions  except  the  one  final  distribution  of  the 
net  result  of  all  the  changes.  In  corporation  accounting,  how- 
ever, the  adjustment  account  has  little  value,  as  the  various 
charges  and  credits  can  be  carried  directly  to  surplus  without 
loss  in  clerical  speed.  The  surplus  account  as  a  part  of  the 
revenue  statement  might  be  attached  in  the  following  form: 

Net  Profits  for  Year  $ 

Surplus  at  the  Beginning  of  Year  


Total  Surplus  

Add: 

Portion  of  Bad  Debt  Reserve  $ 

Profits  from  Sale  of  Fixed  Assets  

Extraordinary  Profits  from  Other 

Soiuxes  

Surplus  Credit  Adjustments  

Deduct : 

Reduction  in  Valuation  of  Land  

Loss  from  Sale  of  Fixed  Assets  

Extraordinary  Losses  

Balance  Surplus  

Dividends  on  Stock  

Final  Surplus,  End  of  Year  

Appropriations: 

Reserve  for  Sinking  Fimd  

Reserve  for  Improvements  

Balance  Unappropriated  Surplus  $ 

The  inclusion  of  a  form  similar  to  the  one  shown  above  will  in- 
dicate as  a  part  of  the  revenue  statement  the  entire  disposition 
of  the  profits  for  the  year  and  of  all  former  profits  earned  by 
the  corporation. 

17.  Limitations  to  the  Payment  of  Dividends.  —  In  many 
states  there  is  a  statute  prohibiting  the  declaration  of  dividends 
except  from  profits  and  accumulated  profits  of  the  corporation. 


CHANGES   IN  VALUE  OF  PROPRIETARY    INTEREST      393 

It  is  intended  by  these  laws  to  prevent  the  gradual  dissipation 
of  the  original  investment  of  the  stockholders  through  the  pay- 
ment of  dividends,  and  thereby  protect  not  only  the  interests 
of  the  stockholders  themselves  but  the  interests  of  the  credit- 
ors of  the  corporation.  This  statute  is,  however,  not  properly 
enforced  until  it  is  comb  ned  with  a  requirement  that  deprecia- 
tion reserves  be  set  up  covering  the  value  of  assets  which  dis- 
appear through  use  and  obsolescence.  The  courts  have  in  some 
instances  interpreted  the  statute  to  require  the  setting  up  of 
appropriate  charges  to  depreciation,  but  in  other  states  there 
are  conflicting  court  decisions.  In  those  states  where  neither 
the  decision  of  the  courts  nor  the  statutes  require  depreciation 
charges  against  the  fixed  assets  little  can  be  accomplished  by  a 
statute  prohibiting  the  declaration  of  dividends  except  from  the 
profits  or  accumulated  profits  of  the  corporation.  In  the  case 
of  some  corporations  such  as  mining  enterprises,  oil  property 
and  mineral  deposits  of  all  kinds,  it  is  obvious  that  the  original 
investment  will  tend  to  disappear  if  the  ownership  of  assets  is 
confined  to  a  specific  deposit.  As  this  deposit  of  coal,  oil,  or 
other  mineral  is  extracted,  no  valuable  asset  remains  except 
the  scrap  value  of  the  machinery  and  assets  used  in  develop- 
ing the  enterprise.  It  might  not  even  be  desirable  that  the 
original  capital  investment  should  be  maintained  in  such  an 
enterprise.  The  courts  have  not,  in  general,  required  corpora- 
tions engaging  in  the  exploitation  of  such  natural  resources  to 
set  aside  reserves  covering  the  reductions  of  fixed  assets  through 
mining  operations. 

18.  Sinking  Funds.  —  The  creation  of  sinking  funds  involves 
an  appropriation  of  a  part  of  the  accumulated  surplus  of  the 
corporation.  The  appropriation  is  similar  to  that  of  appropri- 
ating surplus  for  improvements.  The  purpose  of  the  appro- 
priation from  surplus  in  both  cases  is  to  indicate  that  the  sur- 
plus so  appropriated  is  not  available  for  dividends.  But  in 
both  cases  no  funds  are  set  aside  through  the  entries  appropri- 
ating from  surplus.  The  setting  aside  of  funds  involves  a  credit 
to  cash  and  a  charge  to  the  furid  thus  created.  When  bond 
sinking  funds  are  set  aside  they  are  generally  turned  over  to 


394  ACCOUNTING  PRINCIPLES 

the  trustee  for  the  issue  of  bonds  to  be  held  at  compound  m- 
terest  until  the  maturity  of  the  bonds  in  question  The  deed 
of  trust  of  sinking  fund  bonds  will  generally  provide  a  percent- 
age of  the  face  value  of  the  outstanding  bonds  which  shall  be 
set  aside  each  year  for  the  sinking  fund.  The  interest  on  the 
sinking  fund  thus  set  aside  becomes  a  part  of  the  sinking  fund, 
although  it  must  also  be  carried  to  the  surplus  reserve  created 
to  offset  the  fund  thus  set  aside.  If  $100,000.00  of  6  per  cent 
bonds  are  sold  to  mature  20  years  from  date  it  is  not  a  diflficult 
matter  to  determine  the  annuity  which  must  be  set  aside  each 
year  to  amount  to  $100,000.00  in  20  years.  If  we  suppose  that 
the  funds  with  the  trustee  will  yield  4  per  cent  each  year  we 
must  find  the  sum,  which,  set  aside  at  the  end  of  each  year, 
will  amount  to  $100,000.00  in  20  years.  If  an  annuity  of  $1.00 
at  4  per  cent  amounts  to  $29.78  in  20  years  the  $100,000.00  will 
require  an  annuity  of  $100,000.00/29.78,  or  $3357.96.  At  the 
end  of  the  first  year  after  the  issue  of  the  bonds  the  following 
journal  entry  would  be  made: 

(a)  Surplus  3»3S7-9<5 

Sinking  Fund  Reserve  3,357-96 

Contribution  to  sinking  fund  reserve  for  retire- 
ment of  bonds 

(b)  Sinking  Fxmd  Trustee  3,357-96 

Cash  3,357-96 

Charging  trustee  with  annual  sinking  fund 

At  the  end  of  the  second  year  the  trustee  would  report  the  in- 
terest earned  amounting  to,  say,  $134.32.  The  company  would 
also  set  aside  the  annual  amount  required  by  the  deed  of  trust, 
making  the  following  journal  entries: 

(c)  Sinking  Fund  Trustee  134-32 

Interest  on  Sinking  Fund  134-32 

Annual   interest   accumulated  on  the  sinking 
fund 

This  interest  would,  of  course,  go  to  the  credit  of  the  regular 
profit  and  loss  and  be  credited  to  surplus  at  the  close  of  the 
year.    The  company  would  then  include  this  interest  thus  ac- 


CHANGES  IN  VALUE  OF  PROPRIETARY  INTEREST      395 

cumulated  in  its  regular  annual  reservation  from  surplus  as 
follows: 

(d)  Sinking  Fund  Trustee  3,357-96 

Cash  3,357-96 

Charging  trustee  with  annual  sinking  fund 

(e)  Surplus  3,492.28 

Reserve  for  Sinking  Fund  3,492.28 

Charging  surplus  with  annual  sinking  fund 
amount  of  $3,357-96  plus  annual  interest 
of  $134-32 

These  entries  would  take  care  of  the  regular  contributions  to 
the  sinking  fund.  However,  the  corporation  frequently  desires 
to  show  in  the  balance  sheet  how  its  sinking  fund  is  invested. 
Let  us  suppose  that  during  the  second  year  of  the  life  of  the 
bonds  $2000.00  were  in  bonds.  The  original  entry  of  this  in- 
vestment would  be  made  by  the  trustee,  but  the  corporation 
would  receive  in  the  annual  report  of  the  trustee  a  record  of 
this  investment  along  with  the  report  of  interest  earned.  The 
corporation,  then,  in  many  cases,  divides  its  sinking  fund  ac- 
count into  two  accounts,  one  showing  the  cash  and  the  other 
the  investments.  The  sinking  fund  trustee  account  would  then 
be  designated  as  the  sinking  fund  trustee-cash  account.  The 
following  journal  entries  would  set  up  the  second  account: 

(b)  Sinking  Fund  Trustee  Bonds   2,000.00 

Sinking  Fund  Trustee  Cash  2,000.00 

Investment  of  trustee  in  bonds 

The  corporation  could  then  show  the  facts  on  its  annual  bal- 
ance sheet  as  follows: 

Sinking  Fund  Trustee: 

Cash  $4,850.24 

Bonds  2,000.00 

$6,850.24 

It  is  more  common,  however,  to  find  the  two  accounts  on  the 
balance  sheet  as  follows: 

Sinking  Fund  Cash  4,850.24 

Sinking  Fund  Bonds  2,000.00 


396  ACCOUNTING  PRINCIPLES 

19.  Surplus  Reserves  and  Valuation  Reserves.  —  Certain 
reservations  from  earnings  are  made  from  time  to  time  for  the 
purpose  of  offsetting  losses  in  assets.  These  losses  are  really 
expenses  of  the  biisiness  and  should  be  charged  against  the  in- 
come before  the  balance  earnings  could  be  regarded  as  the  net 
profits  Depreciations  of  fixed  assets  is  charged  as  an  expense, 
but  the  amount  so  charged  is  commonly  carried  to  the  credit  of 
a  reserve  for  depreciation,  as  explained  in  pre\'ious  chapters, 
instead  of  being  credited  directly  to  the  assets  which  have  de- 
preciated. This  depreciation  reserve  then  represents  the  amount 
by  which  the  asset  is  overstated  and  is  called  a  valuation 
reserve.  The  reser\'e  for  bad  debts  similarly  should  represent 
the  amoimt  by  which  the  valuation  of  accounts  and  notes  receiv- 
able are  overstated  in  the  balance  sheet  and  is  likewise  a  valua- 
tion reserve.  The  reserves,  however,  which  are  made  for  special 
purposes  other  than  to  offset  decreases  in  assets  are  surplus 
reserves.  If  the  assets  reserved  are  set  aside  in  a  special  fund 
the  reserve  is  spoken  of  as  a  covered  reserve.  The  sinking  fund 
reserve  and  the  reserve  for  improvements  are  surplus  reserves. 
On  accoimt  of  the  fact  that  these  surplus  reserves  are  like  the 
regular  surplus  except  that  they  are  not  available  for  di\'idends 
it  becomes  appropriate  to  retain  these  surplus  reserves  on  the 
liabiUty  side  of  the  balance  sheet  and  to  represent  them  as 
follows: 

Surplus  Reserves: 

Sinking  Fund  Reserve  $ 

Reserve  for  Improvements  

Undivided  Profits  

Balance  Surplus  

Total  $ 

However,  these  special  surplus  reser\'es  are  frequently  shown 
as  separate  items  on  the  liabihty  side  of  the  balance  sheet, 
being  Usted  as  follows: 

Sinking  Fund  Reserve  $ 

Reserve  for  Improvements  

Undivided  Profits  

Surplus  ... . . . . 


CHANGES   IN  VALUE  OF  PROPRIETARY  INTEREST     397 

20.  Total  Proprietary  Interest.  —  The  total  proprietary  in- 
terest of  the  corporation  is  represented  by  the  total  capital 
plus  the  surplus  reserves.  While  the  balance  sheet  frequently 
shows  the  capital  stock  accounts  first  and  the  surplus  reserves 
last  as  representing  the  balance  difference  between  the  assets 
and  liabilities,  the  original  capital  being  thought  of  as  a  type 
of  liability,  much  is  to  be  said  in  favor  of  grouping  all  the  pro- 
prietary items  together  as  follows: 

Proprietorship: 

Capital  Stock  $ 

Surplus  Reserves: 

Sinking  Fund  Reserve  

Reserve  for  Improvements       

Undivided  Profits  

Surplus  

Total 


QUESTIONS   AND   PROBLEMS 

What  is  meant  by  the  net  profits  of  the  corporation? 
The  XYZ  Corporation  has  the  following  balance  sheet: 


Assets 
Plant  and  Property 
Furniture  and  Fixtures 
Merchandise  Inventory 
Cash 

750,000.00 
20,000.00 
75,000.00 
15,000.00 

860,000.00 

Liabilities 
Capital  Stock 
First  Mortgage  Bonds 
Accounts  Payable 
Surplus 

600,000.00 
50,000.00 
30,000.00 
80,000.00 

860,000.00 

(a)  What  is  the  book  value  of  a  share  of  its  stock? 

(b)  On  February  15  the  corporation  declared  a  cash  dividend  of  5  per 
cent,  payable  March  i,  1921.  At  the  same  time  it  declared  a  10  per  cent 
stock  dividend  payable  the  same  date. 

(c)  On  March  i  the  dividends  are  paid.  Journalize  the  entries  involved 
in  (a),  (b),  and  (c). 

(d)  At  the  end  of  the  period  the  net  profits  from  operation  were  $25,- 
000.00.  There  were  set  up  the  following  reserves:  $5,000.00  for  sinking 
fund  and  $10,000.00  for  improvements.  Adjustments  were  made  as  fol- 
lows: furniture  and  fixtures,  written  down  $500.00,  an  error  of  $750  in 
plant  and  property  corrected  by  placing  this  amount  on  the  books. 

Make  out  the  surplus  account  and  show  how  it  would  appear  as  a  part 
of  a  profit  and  loss  statement. 


398 


ACCOUNTING  PRINCIPLES 


(e)  The  corporation  decides  to  expand  its  business  and  consequently 
authorizes  an  increase  in  capital  of  $30o,oc».oo,  each  stockholder  ha\'ing 
the  right  to  purchase  stock  equal  to  50  per  cent  of  his  holdings.  The  shares 
were  selling  for  $125.00  per  share,  the  par  being  $100.00.  \t  what  price 
should  the  rights  sell? 

3.   (a)  The  GHK  Corporation  has  the  following  balance  sheet: 


Assets 

Plant  and  Property 
Furniture  and  Fixtures 
Cash 


600,000.00 

100,000.00 

50,000.00 

750,000.00 


Liabilities 
Capital  Stock  750,000.00 


r50,ooo.oo 


The  stockholders  G,  H,  and  K  donate  pro  rata  $150,000.00  of  stock  to 
the  corporation  for  working  capital.  Of  this  amount  1000  shares  are  sold 
at  $75.00  per  share,  the  par  being  $100.00.  Journalize  and  set  up  the  bal- 
ance sheet  after  the  sale. 

(b)  One  year  later  the  corporation  sells  $100,000.00  of  additic«ial  stock 
to  outsiders  at  $125.00  per  share,  the  par  being  $100.00.  Journalize  the 
sale. 

(c)  It  also  sells  certain  parts  of  plant  and  property  costing  $75,000.00  at 
$85,000.00.  Journalize  the  sale  and  state  how  the  profits  and  loss  account 
would  be  dosed  out  at  the  end  of  the  period. 


CHAPTER  XXDC  ' 
CORPORATION  RECORDS 

I.  Subscription  to  Stock.  —  A  subscription  blank  which 
would  serve  the  purpose  for  a  prospective  subscriber  might 
have  a  form  as  follows: 


ILLUSTRATION  NO.   28 
Subscription  Blank 


Date  of 
Subscription 


Signature  of  Subscriber 


Address  of 
Subscriber 


No.  OF 
Shares 


Amount 


The  prospective  subscriber  would  be  furnished  a  prospectus 
along  with  the  subscription  blank  or  prior  to  his  receipt  of  it. 
The  prospectus  would  give  the  names  of  the  incorporators,  the 
nature  of  the  business  to  be  conducted,  and  such  facts  and 
statistics  as  might  indicate  the  corporate  earnings  which  might 
be  anticipated  so  that  a  prospective  subscriber  might  deter- 
mine for  himself  whether  the  prospect  for  returns  on  the  invest- 
ment justified  the  required  purchase  price.  When  the  sub- 
scription blanks  are  received  they  might  be  entered  in  a  sub- 
scription book  as  they  are  received.  The  book  would  have 
columnar  headings  similar  to  those  of  the  subscription  blank. 
This  book  would  serve  as  a  book  of  original  entry  for  subscrip- 
tions. The  subscription  blanks  themselves  could  also  be  used 
as  the  original  entry  from  which  postings  would  be  made  to  the 
subscription  ledger.  If  an  installment  book  were  used  to  record 
the  payment  of  each  installment,  it  might  have  the  following 
form: 

399 


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ACCOUNTING  PRINCIPLES 


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CORPORATION  RECORDS 


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402  ACCOUNTING  PRINCIPLES 

2.  Subscription  Ledger.  —  The  subscribers'  account  in  the 
general  ledger  would  be  carried  on  ledger  paper  with  ordinary 
rulings.  The  subsidiary  subscription  ledger  is  sometimes  es- 
pecially ruled  somewhat  as  shown  on  previous  page. 

The  form  of  ledger  illustrated  above  is  one  which  would  be 
designed  to  meet  the  needs  of  a  corporation  which  received  its 
subscriptions  payable  on  the  installment  plan.  If  the  individual 
subscribers'  accounts  were  payable  on  the  installment  plan,  it 
would  not  be  necessar\'  to  prescribe  imusual  forms  for  the  sub- 
scription ledger.  The  subscribers'  account  in  the  general  ledger 
would  represent  a  controlling  accoimt  for  the  subscription 
ledger.  When  all  of  the  subscriptions  of  a  given  subscriber  are 
paid  in  full,  he  would  generally  receive  a  stock  certificate,  but 
if  the  stock  certificates  are  not  ready  for  delivery  he  would 
generally  receive  a  treasury  receipt  showing  full  pa\Tnent  for 
the  stock.  This  certificate  would,  in  general,  be  transferable 
and  would  carry  with  it  the  right  to  receive  a  stock  certificate 
when  these  are  ready  for  issue. 

3.  Stock  Book  Certificate.  —  Stock  certificates  are  ordina- 
rily issued  in  serial  numbers.  There  is  a  stub  on  each  stock  cer- 
tificate which  furnishes  all  information  essential  for  posting  to 
the  stock  ledger.  On  this  stub  would  appear  the  certificate 
number,  nimiber  of  shares  issued,  name  and  address  of  holder, 
date  of  issue,  and  from  whom  transferred.-  There  would  also 
be  posted  on  this  stub  a  receipt  or  signature  of  the  individual 
to  whom  the  certificate  was  issued.  The  stock  certificate  ordi- 
narily describes  briefly  on  its  face  the  rights  of  the  holder.  A 
reference  to  the  books  on  corporation  forms  will  show  a  variety 
of  inscriptions  suitable  for  the  face  of  a  corporation  stock  cer- 
tificate. On  the  back  of  the  certificate  there  appears  a  transfer 
blank  which  would  enable  the  holder  to  transfer  the  share  or 
shares  to  another.  The  certificate  may  be  transferred  through 
the  signature  of  the  owner,  but  the  original  owner  continues  to 
be  vested  with  the  right  to  receive  dividends  imtil  the  certificate 
issued  to  him  is  turned  in  to  the  company  for  cancellation.  A 
new  certificate  is  then  issued  to  the  purchaser  and  the  old  cer- 
tificate is  attached  to  the  stub  from  which  it  was  originally 


CORPORATION  RECORDS 


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404  ACCOUNTING  PRINCIPLES 

taken,  as  a  voucher  to  indicate  its  cancellation.  The  stubs  of 
the  stock  certificate  book  should  indicate  the  shares  issued  and 
outstanding.  This  is  also  indicated  on  the  books  of  the  regis- 
trar 

4.  Stock  Transfer  Book.  —  Since  shares  of  stock  are  freely 
transferable,  it  becomes  necessar>'  to  set  up  a  record  showing 
the  transfer  so  that  a  correct  record  may  be  kept  showing  the 
credit  to  each  stockholder  in  the  corporation.  This  record  of 
the  holdings  of  each  stockholder  is  kept  in  the  stockholders' 
record  in  the  stock  ledger.  While  the  stock  certificate  book 
stub  could  be  provided  with  space  to  indicate  the  stock  pur- 
chaser or  purchasers  of  shares  canceled,  there  is  frequently  set 
up  a  regular  stock  transfer  book.  The  form  of  stock  transfer 
book  required  by  the  state  of  New  York  is  shown  on  previous 
page. 

The  following  form  will  serve  to  indicate  the  character  of  in- 
scription found  on  the  face  of  a  stock  certificate: 

United  States  of  America — Incorporated  under  the  Laws  of  the  State 

of 

Number  of  Nmnber  of 

certificate  shares 


The Company  of  the  State  of- 

This  certifies  that is  the  owner  of 


shares  of  stock  of  the Company  of  the  City 

of of  the  state  of ,  transferable 

only  on  the  books  of  the  Corporation  by  the  holder  hereof  in  j>erson 
or  by  attorney  upon  the  surrender  of  this  certificate  properly  en- 
dorsed. 

IN  WITNESS  WHEREOF,  the  said  corporation  has  caused  this 
certificate  to  be  signed  by  its  duly  authorized  oflScers  and  to  be 

sealed  (Seal)  with  the  seal  of  the  Corporation  this  the ^th  day 

of , 


Treasurer.  President. 

5.  Stock  Ledger.  —  A  special  form  for  the  stock  ledger  is 
frequently  found.  The  following  form  of  entry  will  serve  to 
indicate  the  character  of  record  involved: 


CORPORATION  RECORDS 


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ACCOUNTING  PRINCIPLES 


(Left-hand  page) 


ILLUSTRATION  NO.   33 
Bond  Register 

CLASS       Registeked  ist  Mortgage  1915 


No. 

Daie  or 

To  Whom  Issued 

Transferred 

Amocnt 

Bond 

Name 

A0DKE.SS 

Name 

Address 

I 

2 

3 

4 

S 

6 

' 

7 

8 

• 

9 

10 

32 

33 

34 

CORPORATION  RECORDS 


407 


(Right-hand  page) 


Interest  Payable 


January  ist  to  July  ist 


Interest 

1916              1917              1918            igig 

1924       1925 

Remarks 

Date 

Jan.  July 

Jan.   July 

Jan.    July 

Jan.   July 

Jan.   July 

Jan.    July 

_ 

h 

I 

2 

— 





^ 





— 

— 

4 

S 

6 

— 

— 

7 

8 

9 

10 



32 

— 

33 

34 

4o8  ACCOUNTING  PRINCIPLES 

6.  Bond  Forms.  —  Corporation  bonds  also  require  regular 
forms.  The  bonds  are  frequently  classified  from  the  standpoint 
of  their  entry  in  the  books  of  r:cord  as  registered  bonds  and 
coupon  bonds.  The  coupon  bonds  are  payable  to  bearer  and 
have  attached  to  them  coupons  easily  removed  from  the  bond 
form  and  sent  in  to  the  treasurer  of  the  corporation  for  pay- 
ment at  the  respective  interest  dates.  The  coupon  bond  is 
payable  to  bearer  and  no  bond  register  at  the  offices  of  the  cor- 
poration or  in  the  hands  of  the  treasurer  is  required  to  record 
the  names  of  the  holders  of  the  outstanding  bonds.  The  regis- 
tered bond,  on  the  other  hand,  is  transferred  on  the  books  of  the 
company  just  as  corporation  stocks  are  transferred.  The  forms 
on  the  two  previous  pages  will  indicate  the  t}T)e  of  bond  register 
which  may  be  used  to  indicate  the  holders  of  outstanding  bonds. 

The  bond  register  used  for  coupon  bonds  is  one  which  shows 
the  canceled  coupons  which  are  attached  to  the  register.  The 
amount  of  interest  coupons  not  paid  will  be  indicated  by  the 
spaces  on  the  bond  register  not  covered  by  canceled  coupons. 
The  coupon  bond  register  form  may  be  as  follows: 

ILLUSTRATION   NO.   34 
Coupon  Bond  Register 

UNITED  STATES  BOND  AND  MORTGAGE    COMPANY 

BOND   REGISTER 

$1,000.00  8%  TRUST  BOND 


Dated  Jan.  i,  1916 

Due  Jan.  1 

1926 

First  Coupoi 

DtieJulyi,  1916 

14 

7 

20 

13 

6 

19 

12 

5 

16 


IS 


CANCELLED 
COUPON 


CORPORATION  RECORDS  409 

There  is  no  indication  on  this  register  as  to  the  name  and  ad- 
dress of  the  holder  of  the  coupon  bond. 

A  combination  of  coupon  and  registered  bonds  is  sometimes 
used.  The  principal  of  the  bond  is  transferred  and  recorded  in 
a  register  similar  to  the  left-hand  page  of  the  bond  register  il- 
lustrated above.  No  provision,  however,  would  be  needed  for 
interest  payments  except  that  shown  in  the  coupon  bond  regis 
ter  illustrated  above.  In  other  words,  the  right-hand  side  of 
such  a  bond  register  page  would  be  the  coupon  register,  instead 
of  an  interest  record. 

7.  Dividend  Book.  — •  The  dividend  book  of  a  corporation  is 
used  for  the  purpose  of  making  out  a  list  of  stockholders  for 
each  dividend  declaration.  The  spaces  provided  for  on  the 
dividend  book  page  would  be  as  follows: 

a.  Name  of  stockholder. 

b.  To  whose  order  check  should  be  drawn  if  diflferent  from  that  of 

stockholder. 

c.  Mailing  address. 

d.  Number  of  shares. 

e.  Amount  of  dividend  paid. 

f.  Number  of  check  issued  in  payment. 

At  the  head  of  the  list  a  memorandum  would  indicate  the  rate 
of  the  dividend  declaration.  There  are  other  special  forms  and 
records  used  in  connection  with  the  corporation  but  those  cited 
above  will  serve  to  indicate  the  character  of  special  records  re- 
quired for  the  corporation.  The  student  will  readily  see  the 
relation  between  the  books  of  original  entry  and  the  ledgers 
described  above.  An  acquaintance  with  the  purpose  of  these 
records  as  set  forth  in  the  description  of  corporate  accounts  in 
a  preceding  chapter  will  carry  with  it  sufficient  directions  for 
the  use  of  the  corporate  forms. 


CHAPTER  XXX 
COST  ACCOUNTS  AND  TYPES  OF  COST  ACCOUNTING 

1.  Accounting  Problems  of  a  Factory.  —  A  factory  may  en- 
gage in  the  business  of  trading  and  selling  its  own  products  or 
it  may  furnish  its  output  entirely  to  a  selling  organization  so 
that  the  two  enterprises  are  distinct  imits  from  the  standpoint 
of  management.  Such  an  organization  would  involve  a  sepa- 
ration of  cost  into  factory  cost  and  selling  cost.  Even  where 
the  two  functions  are  imder  the  control  of  the  same  manage- 
ment they  are  ordinarily  under  the  supervision  of  separate  de- 
partments and  consequently  the  same  grouping  of  cost  data  is 
found  advisable.  The  selling  costs  and  their  classification  for 
a  factor\'  do  not  differ  materially  from  the  classification  of  sell- 
ing costs  already  described  in  connection  with  the  trading 
business. 

2.  Factory  Costs.  —  The  cost  of  manufacturing  is  ordinarily 
divided  into  two  classes  of  items:  (a)  prime  costs  and  (b)  indi- 
rect expense.  Prime  costs  consist  of  the  wages  of  labor  de- 
voted directly  to  manufacturing  operations  plus  the  cost  of 
materials  used  in  manufacturing.  Indirect  expense  includes  all 
other  expenses  of  manufacture. 

3.  Significance  of  Direct  Labor  Cost  • —  There  is  no  factor  in 
modern  production  which  has  given  more  concern  to  factorj' 
managers  than  the  direct  labor  item.  When  costs  of  produc- 
tion have  been  greatly  reduced  the  reduction  has  been  gener- 
ally concerned  mainly  with  the  reduction  in  the  cost  of  labor. 
The  more  enlightened  managers  have  set  up  the  program  of 
iiicreasing  wages  of  individual  laborers  and  of  reducing,  at  the 
same  time,  the  cost  of  labor  required  to  perform  manufacturing 
operations.  This  can  only  be  achieved  by  so  standardizing  and 
supervising  the  work  to  be  done  that  time  will  be  saved.  If 
several  operat'ons  are  involved  it  may  be  desirable  to  set  up  a 

410 


COST  ACCOUNTS,   TYPES  OF  COST  ACCOUNTING     41 1 

direct  labor  account  for  each  of  two  or  more  divisions  of  the 
factory  work  required  to  produce  a  given  commodity.  In  some 
cases  the  factory  work  is  departmentalized  and  an  account  for 
direct  labor  may  be  required  for  each  department.  Still  an- 
other labor  cost  program  requires  a  record  of  the  direct  labor 
for  each  job  of  work  performed.  This  form  of  charge  is  used 
when  factory  production  goes  forward  on  the  job  order  basis. 
In  some  instances,  however,  the  direct  labor  record  goes  even 
to  the  point  of  showing  the  direct  labor  cost  of  each  operation 
involved  in  factory  production.  Much  of  cost  accounting  work 
is  concerned  with  recording  and  assembling  data  showing  the 
cost  of  labor.  It  is  one  of  the  principal  problems  of  any  cost 
accounting  program. 

4.  Material  Costs.  —  The  recording  of  material  costs  is  at- 
tended with  less  complexity.  It  is  not  difficult  to  keep  a  ma- 
terial account  showing  the  cost  of  all  materials  going  into  the 
production  process.  It  is  frequently  true  that  all  the  material 
is  properly  chargeable  to  the  product  in  one  account  showing 
the  total  material  cost  of  producing  a  commodity.  If  more 
than  one  material  is  used  in  production  there  may  be  more 
than  one  material  account.  If  there  are  departments  one  or 
more  material  accounts  may  be  required  for  each  department. 

5.  Indirect  Expense.  —  In  the  fields  of  factory  production 
where  material  costs  are  a  large  fraction  of  total  costs,  indirect 
expense  is  usually  small  and  no  intricate  or  refined  system  is 
required  for  properly  charging  indirect  expense  if  it  becomes 
necessary  to  apportion  it  between  departments  or  separate 
divisions  of  work.  However,  the  direct  and  indirect  labor  cost 
tend  in  many  lines  of  factory  production  to  constitute  a  large 
fraction  of  total  cost.  In  such  cases  indirect  expense  is  gener- 
ally a  large  fraction  of  total  cost.  A  large  investment  in  fixed 
assets  tends  to  increase  further  the  indirect  expense.  When  in- 
direct expense  becomes  large  any  considerable  error  in  its  dis- 
tribution may  render  the  cost  data  of  little  value.  Much  of 
modern  cost  accounting  is  concerned  with  a  study  of  means  by 
which  an  accurate  distribution  of  indirect  expense  may  be 
made  according  to  the  extent  to  which  it  is  occasioned  by  the 


412  ACCOUNTING  PRINCIPLES 

several   operations,    processes,  departments,  or   commodities 
which  may  be  the  subject  of  cost-finding. 

6.  Types  of  Cost  Systems.  —  The  more  important  types  of 
cost  systems  are:  (a)  the  estimating  cost  system  and  (b)  job 
cost  systems,  which  include  those  employing  the  machine  rate 
as  a  means  of  distributing  indirect  expense  and  those  employing 
other  methods  for  this  purpose.  The  estimating  cost  system 
may  be  carried  on  for  a  plant  as  a  whole  or  the  classifica- 
tion of  costs  may  be  by  departments.  The  subject  of  the  cost- 
finding  may  be  a  commodity,  or  certain  operations  on  the  com- 
modity. The  job  cost  system  of  accounting  is  applicable  to  a 
plant  doing  a  miscellaneous  type  of  foundry  and  machine  work 
largely  on  orders  coming  from  customers,  and  opens  the  possi- 
bility for  accurate  and  dependable  cost-finding.  The  estimat- 
ing cost  system  is  commonly  used  when  approximate  costs  can 
be  secured  in  that  way  provided  the  less  accurate  results  prove 
sufl&cient  for  the  managerial  needs  of  the  factory. 

7.  The  Estimating  Cost  System  and  the  Job  Order  System. 
—  If  a  job  order  system  prevails  all  factory  work  must  be  done 
on  the  basis  of  a  job  order  prepared  under  the  supervision  of  a 
superintendent  of  factory  operations.  The  job  orders  may  be 
prepared  by  a  production  clerk,  a  production  engineer,  or  some 
other  oflScer  charged  with  the  duty  of  arranging  a  production 
program.  The  use  of  the  job  order  requires  ordinarily  the  fol- 
lowing provisions:  (a)  a  storeroom  with  a  perpetual  inventory 
of  raw  materials,  (b)  a  daily  record  showing  the  job  or  jobs  to 
which  the  labor  of  each  workman  is  chargeable,  (c)  a  daily 
record  of  the  issue  of  all  material  from  stock  showing  the  job 
to  which  such  material  is  chargeable,  (d)  a  system  of  apportion- 
ing overhead  expense  to  the  respective  jobs  so  that  a  ledger 
record  in  the  form  of  a  job  order  sheet  may  be  prepared  for 
each  job  showing  its  cost  at  the  time  of  its  completion. 

In  the  case  of  the  estimating  cost  system,  however,  the  situ- 
ation is  quite  different.  The  simplest  situation  would  be  that 
in  which  there  are  just  three  accounts:  (a)  direct  labor;  (b)  di- 
rect material;  and  (c)  indirect  expense.  All  expenditures  made 
on  the  manufacturing  process  would  be  charged  against  one  of 


COST  ACCOUNTS,   TYPES   OF   COST  ACCOUNTING     413 

the  three  accounts  named.  The  sum  of  the  debit  balances  of 
these  three  accounts  should  show  at  all  times  the  total  expen- 
ditures incurred  in  the  manufacturing  process.  The  question 
arises  as  to  whether  this  sum  would  represent  an  accurate  cost 
of  goods  manufactured.  It  would  represent  with  a  fair  degree 
of  accuracy  the  total  cost  of  goods  in  process  of  manufacture 
plus  the  cost  of  finished  goods.  The  difficulty  would  arise  in 
the  separation  of  the  expense  chargeable  to  finished  goods  from 
that  chargeable  to  goods  in  the  process  of  manufacture  but 
not  yet  finished. 

This  separation  of  the  cost  of  finished  goods  from  that  of 
unfinished  goods  takes  place  when  an  inventory  is  taken.  This 
separation  must  take  the  form  of  an  estimate.  There  are  no 
records  which  would  serve  to  make  this  estimate  accurate.  As 
the  processes  of  manufacture  become  more  involved  this  esti- 
mate becomes  less  accurate  and  the  estimating  cost  system 
becomes  less  satisfactory.  There  would  be  no  difficulty  in  mak- 
ing this  separation  for  a  job  cost  system.  The  cost  sheet  would 
show  the  cost  of  finished  work  when  the  work  was  completed. 
Xll  expenses  charged  to  jobs  under  the  several  account  titles 
would  constitute  subsidiary  accounts  under  the  general  con- 
trolling caption  of  work  in  process.  In  the  job  order  system  the 
work  in  process  account  balance  is  the  sum  of  the  debit  balances 
of  all  job  order  accounts  or  job  order  sheets.  But  in  the  estimat- 
ing cost  system  it  is  necessary  to  determine  by  estimate  the 
amount  of  expenditure  on  uncompleted  work.  Since  this  estimate 
can  be  an  approximation  only,  the  cost  of  finished  stock  can  also 
be  only  an  approximation  because  it  is  arrived  at  by  subtract- 
ing the  work  in  process  estimated  item  from  the  total  charges 
to  the  manufacturing  process  in  the  manufacturing  account. 

This  text  is  concerned  only  with  a  simple  case  of  the  esti- 
mating cost  system.  The  more  general  accounts  involved  in 
the  estimating  cost  system  are  about  the  same  as  those  em- 
ployed in  all  of  the  cost  accounting  programs.  Moreover,  the 
voucher  register,  which  is  generally  used  as  a  means  of  dis- 
tributing items  to  the  several  expense  accounts  in  the  esti- 
mating cost  system,  has  a  wide  application  to  many  other  cost 


414  ACCOUNTING  PRmCIPLES 

accounting  programs.  A  simple  estimating  cost  sy-stem  serves, 
therefore,  as  a  suitable  means  of  introducing  the  general  sub- 
ject of  cost  accounting, 

8.  Cost  Accounts.  —  It  was  pointed  out  above  that  the  prin- 
cipal accounts  are  direct  labor,  direct  material,  and  indirect 
expense.  In  the  job  cost  sv'stem  the  cost  sheet  commonly 
shows  both  the  direct  labor  and  direct  material  in  separate  col- 
umns. There  is  substantially  a  separate  direct  labor  accoimt 
for  each  job,  although  no  formal  ledger  account  may  be  opened 
except  for  the  general  direct  labor  control.  Exactly  the  same 
thing  may  be  said  for  the  material  accounts  and  the  geribral 
material  control  account.  In  the  estimating  cost  system  there 
might  be  two  or  more  direct  labor  accounts  corresponding  to 
the  several  departments  or  the  several  divisions  of  the  work 
involved  in  manufacturing.  There  might  be  the  same  number 
of  material  accounts  or  there  might  be  only  one  material  ac- 
count for  the  several  divisions  of  the  work.  In  the  estimating 
cost  s\^tem  as  well  as  in  other  cost  accounting  programs  the 
indirect  expense  is  usually  the  caption  of  a  group  of  accounts 
instead  of  being  an  accoimt  title.  Some  of  the  more  common 
indirect  expense  accotmts  are  as  follows:  (a)  shop  suppUes, 
(b)  heat,  light,  and  power  used  in  manufacture,  (c)  factory  re- 
pairs, (d)  factory  insurance,  (e)  administrative  salaries,  (f)  ad- 
ministrative expense,  (g)  depreciation  of  machiner>%  and  (h)  de- 
preciation of  building. 

One  of  the  characteristics  of  factory  accounting  as  contrasted 
with  the  smaU  retail  estabhshment  lies  in  the  large  mmiber  of 
accounts  to  which  charges  must  be  made. 

g.  Manufacturing  Account.  —  The  manufacturing  account 
bears  the  same  relation  to  the  factory  accounts  that  the  trad- 
ing and  profit  and  loss  accounts  bear  to  the  accounts  of  the 
trading  business.  It  is  the  dosing  account  into  which  the 
various  expense  items  are  grouped  for  the  purpose  of  arriving 
at  the  total  cost  of  manufacturing  finished  goods. 

The  following  skeleton  of  a  manufactiuing  account  indicates 
the  detailed  accoimts  closed  into  manufacturing  at  the  time  of 
closing  the  books: 


COST  ACCOUNTS,  TYPES  OF   COST  ACCOUNTING    415 


MANUFACTURING  ACCOUNT 


Raw  Material  Inv.  First  of 

Raw  Material  Inv.  End  of 

Period                                  .... 

Period                                   . . . . 

Goods  in  Process  First  of 

Goods  in  Process  End  of 

Period                                  .... 

Period                                   

Materials  Purchased               .... 

Shop  Supplies  Inv.  End  of 

Direct  Labor                           .... 

Period                                   .... 

Indirect  Labor                         .... 

Manufacturing  Cost  Car- 

Frt. on  Mat.  Purchased          .... 

ried  Down                            

Cartage  on  Mat.  Purchased     .... 

Shop  Supplies                          .... 

Heat  and  Power  Used  for 

Mfg. 

Misc.  Fac.  Expense                 .... 

Repairs  to  Mchy.  and  Tools     .... 

Factory  Insurance                   

Depreciation: 

Mfg.  Machinery                  

Mfg.  Building                       

■ 

Other  Mfg.  Equip.              .... 

Taxes  on  Mfg.  Property         .... 

If  it  were  desired  to  get  a  correct  figure  for  direct  labor  per 
unit  of  finished  product,  a  direct  material  cost  per  unit  of  prod- 
uct, and  an  indirect  expense  per  unit  of  product,  it  would  be- 
come necessary  to  divide  the  process  account  as  follows: 

Goods  in  process,  direct  labor. 
Goods  in  process,  direct  material. 

Goods  in  process,  indirect  expense.  (This  account  includes  as  a 
total  all  accounts  other  than  direct  labor  and  material) 

In  setting  up  the  respective  accounts  at  the  beginning  of  a 
subsequent  period  the  following  journal  entry  should  be  made: 

Direct  Labor  

Direct  Material  

Indirect  Expense  

Goods  in  Process  

Charging  the  goods  in  process  to  the  several 
cost  accounts. 


4l6  ACCOUNTING  PRINCIPLES 

It  is  clear,  therefore,  that  when  unit  costs  are  employed  the 
goods  in  process  item  would  appear  in  the  beginning  of  the 
period  as  the  total  of  the  charges  to  direct  labor,  material,  and 
indirect  expense.  The  goods  in  process  items,  even  at  the  end 
of  the  period,  should  preferably  be  entered  as  credits  to  the 
direct  labor,  direct  material,  and  indirect  expense  accounts,  if 
unit  costs  are  to  be  calculated.    The  entry  would  be  as  follows: 

Gioods  in  Process      Inv 

Direct  Labor  

Material  

Indirect  Expense  

The  balances  of  the  direct  labor  account,  the  direct  material 
account,  and  the  indirect  expense  account  would  then  be  the 
expenditures  on  these  accounts  for  finished  goods,  and  the  bal- 
ance of  the  manufacturing  account  would  be  the  cost  of  fin- 
ished goods.  In  this  discussion  all  of  the  indirect  expense  ac- 
counts have  been  treated  as  a  total  for  brevity.  In  practice  a 
unit  cost  for  each  of  these  items  would  require  that  it  be 
treated  just  as  the  direct  labor  and  direct  material  accounts 
were,  the  respective  accounts  being  credited  at  the  time  of 
closing  with  so  much  of  the  item  as  might  be  chargeable  to  the 
goods  in  process  inventory. 

The  journal  entr\'  involved  in  closing  the  several  accounts 
into  the  manufacturing  accoimt  are  similar  to  those  involved 
in  closing  the  accoxmts  of  a  trading  firm  into  the  trading  and 
profit  and  loss  accounts.  The  closing  entries  can  be  abbre- 
viated in  the  same  way  by  compound  entries. 

The  balance  of  the  manufacturing  account  is  brought  down 
to  the  trading  account  by  the  following  journal  entry: 

Trading  —  Mfg.  Cost  

Manufacturing  —  Mfg.  Cost  

Bringing  down  the  balance  of  the  manufac- 
turing account  to  trading. 

The  journal  entries  involved  in  the  irading  account  can  be 
readily  supplied  by  observation  of  the  following  skeleton  of  the 
account : 


COST  ACCOUNTS,   TYPES  OF   COST  ACCOUNTING    417 
TRADING 


Mfg.  Cost 

Fin.  Stock,  First  of  Period 
Fin.  Stock  Purchases 
Frt.  in  on  Fin.  Stock  Pur- 
chases 
Gross  profit 


Finished  Stock  Sales 
Fin.  Stock  Inv.  End  of 
Period 


The  gross  profit  balance  is  then  brought  down  to  profit  and 
loss  and  the  closings  into  profit  and  loss  are  made  as  set  forth 
in  preceding  chapters. 

Paragraphs  10,  11,  and  12  maybe  omitted  for  first-year  stu- 
dents. This  would  also  involve  the  omission  of  No.  12  in  Prob- 
lems and  Questions  at  the  end  of  the  chapter.  The  paragraphs 
are  necessary,  however,  for  a  complete  understanding  of  the 
simplified  cost  systems  which  rely  upon  a  voucher  register  for 
the  distribution  of  cost  expense. 

ID.  Estimating  the  Goods  in  Process.  —  In  order  to  set  up 
some  standard  cost  data  and  facilitate  the  inventory  of  goods 
in  process  an  estimate  is  frequently  made  showing  the  expected 
cost  of  a  product  to  be  manufactured.  This  estimate  is  ana- 
lyzed into  the  cost  of  the  separate  operations  to  be  performed 
on  the  commodity  so  as  to  show  direct  labor,  direct  material, 
and  indirect  expense  for  each  operation. 

Suppose,  for  example,  the  unit  cost  of  a  commodity  A  were 
estimated  as  follows: 

TABLE  XXX-A 

Estimated  Operation  Unit  Costs 


Total 
Cost 

Operation 
No.  3 

Operation 
No.  2 

Operation 
No.  I 

Material 

Direct  Labor   .... 
Indirect  Expense       .     . 

$3.00 
I.OO 

•so 

$3-oo 

•SO 

•2S 

.20 
.10 

•30 

•15 

Totals 

$4.50 

$3^7S 

•30 

•4S 

4i8 


ACCOUNTING  PRINCIPLES 


It  would  be  possible  by  test  performances  of  these  separate 
operations  and  by  comparing  the  result  with  experience  records 
in  bulk  production  to  set  up  a  standard  unit  cost  estimate 
which  would  be  applied  to  the  work  in  process  in  various  stages 
of  production  so  that  the  inventory  might  be  made. 

Let  us  suppose,  further,  that  at  the  end  of  a  month  10,000 
units  of  commodity  A  have  been  completed,  1000  additional 
completed  through  Operation  No.  i,  and  500  additional  through 
Operation  No.  2.  The  additional  items  are  work  in  process. 
On  the  basis  of  the  estimated  costs  the  following  would  be  the 
work  in  process  inventory: 

TABLE  XXX-B 

Work  in  Process  on  the  Basis  of  the  Estimated  Operation 

Unit  Costs 

Oper.  #2 


Direct  Material 
Direct  Labor 
Indirect  Expense 


Oper.  #1 

$3,000.00 

500.00 

250.00 


$3,750.00 


$100.00 
50.00 


$150.00 


Total 
,000.00 
600.00 
300.00 


$3,900.00 


If  the  estimates  had  all  been  correct,  the  total  expenditures  to 
date  would  be  as  shown  in  the  table  on  the  following  page: 


13  lines  short 


COST  ACCOUNTS,  TYPES  OF  COST  ACCOUNTING     419 


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420  ACCOUNTING  PRINCIPLES 

But  the  voucher  register  may  be  supposed  to  show  the  fol- 
lowing expenditure  after  due  elimination  of  materials  on  hand 
which  have  not  been  placed  into  factory  process; 


TABLE  XXX-D 

Actual    Total    Manufacturing    Costs    Including    Work    in 
Process  Taken  frou  Financial  Records 

Direct  Material  $32,500.00 

Direct  Labor  1 1 ,000.00 

Indirect  Expense  5,600.00 

This  would  be  regarded  as  proof  that  the  estimates  were 
approximately  correct.  Yet  the  material  unit  estimate  was  too 
high  by  500/33,000  or  1.5  cents  per  unit  of  estimated  cost.  The 
labor  estimate  was  slightly  too  low  because  the  expenditure  on 
the  estimated  basis  was  less  than  the  actual  expenditure.  The 
same  would  be  true  of  indirect  expense.  These  facts  may  be 
verified  by  comparing  Table  XXX-D  with  the  All  Operations 
column  of  Table  XXX-C. 

It  would  not  be  possible  to  get  the  actual  cost  per  unit  for 
each  operation  unless  we  assume  that  the  direct  labor,  direct 
material,  and  indirect  expense  costs  for  the  actual  expenditures 
are  in  the  same  proportion  as  between  the  three  operations  as 
they  are  found  to  be  in  the  case  of  the  estimated  expenditures. 
This  assumption  is  not  unreasonable,  however,  since  the  esti- 
mated costs  are  usually  set  up  on  the  basis  of  job  cost  data 
taken  for  sample  batches  of  items  nm  through  the  factory 
under  a  job  cost  accounting  analysis.  The  job  cost  analysis 
may  be  applied  to  a  sufficient  number  of  batches  to  satisfy  the 
management  that  representative  data  have  been  secured  for 
the  estimate.  Of  course  no  accurarte  costs  can  be  found  by  the 
use  of  the  estimating  cost  system.  But  the  original  estimate 
will  at  least  be  subject  to  correction  for  a  closer  approximation 
on  the  basis  of  the  total  costs  when  it  is  found  that  the  total 
costs  on  the  estimated  basis  do  not  agree  with  the  total  costs 
as  taken  from  the  financial  records  which  show  the  actual  ex- 


COST  ACCOUNTS,  TYPES  OF  COST  ACCOUNTING     421 


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422  ACCOUNTING  PRINCIPLES 

penditures  for  direct  labor,  direct  material,  and  indirect  ex- 
penses. If  we  now  divide  the  actuzd  cost  totals  between  the 
three  operations  for  the  three  items  on  the  same  percentage 
basis  as  they  are  found  to  be  divided  in  the  estimated  cost 
table  on  p.  419,  we  will  have  the  table  as  shown  on  the 
previous  page. 

When  one  has  taken  the  inventory  by  the  use  of  the  esti- 
mated costs  the  question  arises  as  to  whether  the  estimates 
have  any  other  useful  purpose.  It  is  obvious  that  the  Unit 
Costs  foimd  in  Table  XXVI-E  could  be  used  in  closing  the 
manufacturing  account  and  in  setting  up  the  work-in-process 
inventory.  The  total  estimated  costs  need  not  even  be  entered 
in  the  books  of  original  entry.  They  serve  their  purpose  in  in- 
dicating how  to  distribute  actual  cost  data  between  the  sev- 
eral operations. 

II.  Jotimal  Entry  of  Estimated  Cost  Data.  —  There  may  be 
an  advantage,  in  some  cases,  in  entering  the  estimated  cost 
data  in  the  journal  and  later  correcting  the  estimated  entries 
before  the  final  closing  of  the  books.  There  are  two  items  of 
data  which  can  be  secured  by  this  practice.  The  total  direct 
labor,  direct  material,  and  indirect  expense  might  be  charged 
weekly  or  daily  to  manufacturing.  If  the  manufacturing  ac- 
count is  credited  with  the  cost  of  finished  stock  on  the  basis  of 
the  estimated  unit  costs,  then  the  daily  or  weekly  balance  of 
the  manufacturing  accoimt  would  show  to  the  management 
the  approximate  cost  to  date  of  all  work  in  process.  At  the 
same  time,  however,  the  manufacturing  account  would  be  cred- 
ited with  the  cost  of  finished  stock  under  the  account  caption 
of  manufacturing  cost.  This  account  would  be  debited  with  the 
same  figiu-e.  This  would  show  the  total  approximate  cost  of 
all  finished  stock.  This  cost  less  cost  of  finished  stock  sold 
would  show  an  approximate  inventory  of  finished  stock  daily 
or  weekly,  as  the  case  might  be.  Assiuning,  therefore,  that  the 
estimated  costs  are  entered  in  the  financial  records,  let  us  see 
how  the  cost  data  referred  to  above  would  be  shown. 

When  the  10,000  items  had  been  finished  the  following  jour- 
nal entry  would  be  made: 


COST  ACCOUNTS,   TYPES  OF  COST  ACCOUNTING     423 

(a)  Manufacturing  Cost  48,ocx>.oo 

Direct  Materials  33,000.00 

Direct  Labor  *  10,000.00 

Indirect  Expense  5,000.00 

(See  Table  XXX-A  above  for  unit  costs) 

The  debits  to  the  direct  material,  direct  labor,  and  the  indirect 
expense  accounts  would  be  from  the  financial  books  showing 
the  expenditures  under  these  captions.  The  sum  of  the  bal- 
ances of  these  several  accounts  would  show  the  work  in  pro- 
cess total.  This  would  produce  an  estimated  cost  of  work  in 
process. 

When  manufacturing  cost  is  thus  entered  on  the  estimating 
cost  basis,  then  the  balance  of  the  manufacturing  account  be- 
comes the  cost  of  work  in  process  instead  of  the  manufacturing 
cost,  which  was  shown  as  the  balance  in  the  illustration  of  the 
manufacturing  account  given  in  paragraph  9  above. 

If  it  were  desired  at  the  end  of  the  month  to  close  the  books 
without  taking  an  actual  inventory  of  work  in  process,  a  trial 
balance  might  be  taken  and  the  estimated  net  profits  worked 
out  through  the  use  of  the  estimated  cost  units.  If  this  pro- 
gram were  adopted  there  would  be  a  use  of  the  estimated  cost 
data  in  connection  with  sales. 

Let  us  suppose  that  the  10,000  units  referred  to  represented 
the  output  for  January  and  the  sales  for  the  same  month  had 
been  9000  items.  The  entry  of  this  item  can  be  made  by  ref- 
erence to  the  data  in  Table  XXX-A  as  follows: 

(b)  Trading  —  Cost  of  Sales 

(at  $4.50  per  unit)  40,500.00 

Manufacturing  Cost  40,500.00 

If  we  suppose  the  9000  items  to  be  sold  on  time  at  $6.00  per 
item,  the  entry  would  be  as  follows: 

(c)  Accounts  Receivable  (Detailed)   54,000.00 

Trading  —  Sales  54,000.00 

The  indirect  expense  can  be  closed  into  profit  and  loss  and 
show  the  estimated  net  profits  after  the  gross  profits  have  been 
calculated. 


424 


ACCOUNTING  PRINCIPLES 


TRADING 


Manufacturing  Cost 
Gross  Profits 


40,500.00 
13,500.00 


54.000.00 


Sales 


54,000.00 


54.000.00 


The  general  indirect  expense  other  than  the  factory  indirect 
would  be  shown  by  the  financial  records.  This  would  include 
the  selling  expenses  and  general  administrative  expenses.  These 
would  be  charged  to  the  profit  and  loss,  which  would  also  be 
credited  with  the  gross  profits.  The  balance  of  the  account 
would  show  the  net  profits  on  the  basis  of  the  estimated  cost 
data. 

12.  Journal  Entries  to  Correct  Estimated  Figxires.  —  It  was 
pointed  out  in  the  preceding  paragraph  that,  in  practice,  the 
monthly  profit  and  loss  statement  might  be  made  five  months 
in  succession  without  an  inventory  by  count,  the  costs  and  in- 
ventory taken  on  the  basis  of  the  estimated  unit  costs  being 
relied  upon.  At  the  end  of  the  sixth  month  a  statement  would 
be  made  in  most  cases  for  the  entire  six  months  and  the  book 
inventory  would  be  checked  with  the  actual  inventory  by 
count.  At  such  a  time  the  unit  cost  data  would  also  be  revised 
as  indicated  in  the  preceding  paragraph. 

For  the  purpose  of  abbreviating  the  discussion  let  it  be  sup- 
posed that  the  estimated  data  are  corrected  for  the  month  of 
January  for  which  entries  were  made  in  the  preceding  para- 
graph. The  final  items  to  be  corrected  are  the  cost  of  sales  item 
and  the  inventory  of  finished  stock.  Then  a  re\ased  profit  will 
result.  Now  let  us  compare  the  estimated  and  the  actual  data 
for  the  10,000  completed  items  as  shown  on  the  next  page: 


COST  ACCOUNTS,  TYPES  OF  COST  ACCOUNTING     425 

TABLE   XXVI-F 
Differences  of  Actual  and  Estimated  Cost  Items 


Material    . 
Direct  Labor  . 
Indirect  Expense 


Actual 

(See  Table 

26-E) 


529,550.00 

10,037.00 

5,290.00 


Estimated 

(See  Table 

26-A) 


530,000.00 

10,000.00 

5,000.00 


Excess  (+)  or 
Shortage  (— ) 
OF  Estimate 


+  $450-00 

-  37.00 

—  290.00 


The  original  entry  for  the  estimated  data  shown  above  was 
as  follows: 


Finished  Stock 
Material 
Direct  Labor 
Indirect  Expense 


48,000.00 


33,000.00 

10,000.00 

5,000.00 


But  the  items  are  in  error  and  hence  the  balances. for  work 
in  process  from  the  several  accounts  will  be  in  error.  How- 
ever, the  estimated  items  can  be  brought  to  the  actual  balances 
by  the  following  correcting  entry  in  the  journal. 


Material 

Finished  Stock 
Direct  Labor 
Indirect  Expense 


450.00 


123.00 

37.00 

290.00 


Entry  to  correct  the  balances  of  the  several  accounts 
resulting  from  entry  of  estimated  data. 

When  the  original  material  account  was  credited  with 
$30,000.00  instead  of  $29,550.00,  the  balance  of  this  account 
was  reduced  excessively  by  the  $450.00.  Likewise  direct  labor 
account  was  left  with  a  balance  of  $37.00  too  much  because  of 
the  credit  of  $10,000.00  when  $10,037.00  should  have  been 
credited.  Likewise  the  indirect  expense  balance  was  left  with 
too  large  a  balance.  The  correcting  entry,  however,  brings  all 
the  estimated  account  balances  into  accord  with  the  actual 


426 


ACCOUNTING  PRINCIPLES 


figures  taken  from  the  financial  record.  The  error  in  finished 
stock  would  of  course  be  the  net  error  of  $123.00  as  shown  by 
the  above  table.  The  several  accounts  with  all  the  corrections 
would  now  stand  as  follows: 


Matkrtal 

Jan. 

31 
31 

BjJance 

32,500.00 
450.00 

Jan.  31 
31 

Labor 

Balance 

30,000.00 
2,950.00 

32,950.00 
2,950.00 

Direct 

2.050.00 

Feb. 

I 

Jan. 

31 

Balance 

11,000.00 
11,000.00 

Jan.  31 
31 
31 

Balance 

10,000.00 

37.00 

11,000.00 

11.000.00 

Feb. 

I 

11,000.00 

INDIRECT  EXPENSE 


January  31 

5,600.00 

Januar>-  31 

Balance 

5.000.00 
290.00 
310.00 

5.600.00 

5,600.00 

February  i  Balance 

310.00 

The  sum  of  the  balances  of  the  three  accoimts  would  give  the 
corrected  work  in  process  account,  the  total  being  $4223.00 
which  is  $323.00  in  excess  of  the  work  in  process  on  the  basis 
of  the  estimated  imit  cost  (Table  XXX-B). 

Before  giving  the  revised  finished  stock  and  sale  accounts  it 
will  be  necessary  to  make  a  journal  correction  for  the  entry  of 
the  sale  of  9000  items  credited  to  finished  stock  on  the  esti- 
mated basis.  The  revised  unit  cost  (Table  XXX-E)  was 
$4,521,  so  that  the  revised  credit  for  the  sale  of  9000  items 
would  be  $40,689.00  instead  of  $40,500.00,  the  old  credit  show- 
ing a  shortage  of  $189.00.    The  correcting  entry  would  be: 


COST  ACCOUNTS,  TYPES  OF  COST  ACCOUNTING      427 

Sales  —  Cost  of  Sales  189.00 

Manufacturing  Cost  189.00 

Correcting  entry  for  credit  to  finished  stock  on 
estimated  basis. 


MANUFACTURING  ACCOUNT 


Jan.  31.    Direct  Mate- 
rials 
Direct  Labor 
Indirect  Exp. 

2,950.00 
963.00 
310.00 

Jan.  31. 

Work  in  Pro- 
cess 

4,223.00 

4,223.00 

4,223.00 

Feb.   I.    Balance  Work 
in  Process 

4,223.00 

MANUFACTURING  COST 


Jan.  31. 

Direct  Mate- 

Jan. 31. 

Cost  of  Sales 

40,500.00 

rials 

33,00000 

Correction 

189.00 

Direct  Labor 

10,000.00 

Correction 

123.00 

Indirect  Exp. 

5,000.00 

Balance  Mfg. 

Balance  Fin- 

Cost 

7,188.00 

48,000.00 

48,000.00 

Feb.    I. 

ished  Stock 

7,188.00 

TRADING   (JANUARY) 


Cost  of  Sales 
Error  in  Est. 
Gross  Profits 


40,500.00 

iSp.oo 

13,311.00 

54,000.00 


Sales 


54,000.00 


54,000.00 


These  entries  bring  the  estimated  figures  into  accord  with 
the  actual  financial  figures  of  the  journals  and  hence  these 
latter  data  are  not  posted.  They  are  simply  used  as  a  basis  of 
correcting  the  estimated  data. 

13.  The  Distribution  of  Indirect  Expense.  —  If  exactly  the 
same  operations  or  series  of  operations  are  performed  on  each 
item  of  factory  product,  the  indirect  expense  can  be  appor- 


428  ACCOUNTING  PRINCIPLES 

tioned  accurately  by  charging  the  same  amount  to  each  unit 
of  product.  Practically  all  manufacture  proceeds  on  the  basis 
of  estimated  costs  with  also  an  estimated  amount  of  indirect 
expense.  The  voucher  record  with  a  monthly  closing  of  the 
books  would  indicate  each  month  the  extent  to  which  the 
actual  indirect  expenses  exceeded  the  estimate.  There  are  two 
other  t}^s  of  distribution  of  indirect  expense  frequently  re- 
sorted to  in  the  simpler  t}'pes  of  manufacture.  In  the  one,  a 
percentage  of  direct  wages  is  added  to  cover  indirect  expense; 
in  the  other,  indirect  expenses  are  distributed  on  the  basis  of 
the  number  of  hours  of  direct  labor  involved  in  the  productive 
processes  concerned.  \\Tien  the  wages  of  direct  labor  are  com- 
paratively uniform,  and  the  amount  of  investment  in  machinery 
comparatively  small,  it  frequently  happens  that  the  cost  of 
supervision  and  the  other  indirect  expenses  may  be  fairly  ap- 
portioned by  either  of  these  two  methods.  It  is  usually  neces- 
sary', however,  to  classify  the  indirect  expenses  into  a  variety 
of  accounts  to  be  distributed  to  the  departments  or  products 
by  different  methods.  For  example,  the  cost  of  heating  might 
be  fairly  distributed  to  departments  on  the  basis  of  floor  space 
or  cubical  content  of  the  rooms.  Power  and  light  costs  are  fre- 
quently distributed  on  the  basis  of  the  capacity  of  the  electric 
fixtures  in  the  various  departments.  There  are  other  indirect 
expenses  such  as  depreciation,  interest,  and  taxes  which  would 
be  distributed  to  the  various  departments  on  the  basis  of  the 
investment  involved  in  their  operation.  One  must  analyze  for 
each  tNpe  of  indirect  expense  the  basis  upon  which  it  may  be 
occasioned  in  various  productive  processes  carried  on  in  the 
factory.  The  distribution  of  indirect  expense  through  a  ma- 
chine rate  is  another  method  used  in  cost  accounting,  but  its 
treatment  is  outside  the  scope  of  a  general  text. 

14.  Cost  Terminology.  —  In  this  chapter  a  selection  of  terms 
has  been  made  and  they  have  been  used  as  if  there  were  no 
other  conflicting  usage.  The  term  productive  labor  is  frequently 
used  instead  of  direct  labor.  The  term  unproductive  labor  is 
also  used  instead  of  the  term  ifidirect  labor.  The  terms  over- 
head expense  and  burden  are  widely  used  instead  of  factory  in- 


COST  ACCOUNTS,  TYPES   OF  COST  ACCOUNTING      429 

direct  expense.  Indirect  expense  may  be  used  without  quali- 
fication, as  in  this  chapter,  provided  only  factory  cost  is  under 
discussion.  But  trading  and  selling  costs  are  also  indirect  ex- 
pense. When  the  costs  of  the  entire  factory  enterprise  are 
under  discussion  the  indirect  expenses  of  the  factory  should  be 
designated  as  factory  indirect  expense  to  distinguish  them  from  the 
general  administrative  and  selling  expenses,  which  are  also  in- 
direct expenses.  The  latter  group  of  indirect  expenses  may  be 
designated  as  general  indirect  expenses. 

QUESTIONS   AND   PROBLEMS 

1.  What  are  the  principal  divisions  of  factory  cost? 

2.  With  what  items  are  modem  factory  problems  chiefly  associated? 

3.  What  divisions  are  sometimes  found  in  the  direct  labor  account? 
How  is  the  number  of  such  accounts  determined? 

4.  What  determines  the  number  of  material  accounts  to  be  kept? 

5.  What  circumstances  of  factory  production  cause  large  indirect  ex- 
pense? 

6.  Contrast  the  estimating  cost  system  with  a  job  order  system.  Dis- 
cuss the  type  of  factory  to  which  each  is  suited. 

7.  (a)  How  is  the  work  in  process  account  set  up  in  the  estimating  cost 
system? 

(b)  In  a  job  order  system? 

8.  What  are  the  means  adopted  to  aid  in  the  estimate  of  work  in 
process? 

9.  Suppose  factory  operations  to  be  duly  efficient  and  properly  stand- 
ardized, how  would  erroneous  estimate  cost  data  be  corrected? 

ID.   Describe  the  content  and  use  of  the  manufacturing  account. 

II.  Make  the  journal  entries  necessary  to  close  the  accounts  of  the 
American  Manufacturing  Co.  from  the  trial  balance  and  adjusting  entries 
below.  Make  the  manufacturing  account,  trading  account,  surplus  account, 
profit  and  loss  account,  and  balance  sheet. 

The  American  Manufacturing  Co.,  a  corporation,  manufactures  patented 
pump  jacks.  It  also  deals  in  engineers'  supplies.  A  trial  balance  of  the 
general  ledger,  June  30,  1908,  disclosed  the  following  conditions: 


Land 

20,000.00 

Buildings  (cost,  July  i,  1907) 

64,000.00 

Reserve  for  Depreciation — ^Building 

1,600.00 

Real  Estate  Mortgage 

24,000.00 

Machinery  and  Tools 

52,000.00 

Reserve  for  Depreciation — Machinery  and 

Tools 

2,600.00 

Horses  and  Wagons 

3,400.00 

Furniture  and  Fixtures 

600.00 

Patents 

16,000.00 

430  ACCOUNTING  PRINCIPLES 


Inventories,  January  i,  1908: 

Raw  Materiak 

25,200.00 

Goods  in  Process 

16,100.00 

Pump  Jacks  (Finished  Goods) 

42,040.00 

Engineers'  Supplies 

28,620.00 

Notes  Receivable 

20,000.00 

Accounts  Receivable 

96,000.00 

Cash 

4,440.00 

Notes  Payable 

24,000.00 

Accounts  Payable 

65,100.00 

Capital  Stock 

200,000.00 

Treasury  Stock 

30,000.00 

Surplus 

44,160.00 

Raw  Material  Purchases 

67,300.00 

Freight  —  Raw  Material  Purchases 

5,240.00 

Productive  Labor 

77,820.00 

Non-productive  Labor 

21,800.00 

Superintendence  —  Factory 

7,000.00 

Heat,  Light,  and  Power 

55,220.00 

Shop  SuppUes 

2,380.00 

Miscellaneous  Factory  Expense 

1,640.00 

Cartage 

3,200.00 

Stable  Expense 

1,660.00 

Insurance  —  Factory  Building  and  Stock 

1,860.00 

Repairs  to  Buildings 

820.00 

Repairs  to  Machinery  and  Tools 

720.00 

Advertising 

10,520.00 

Taxes 

1,000.00 

Salesmen's  Salaries 

7,500.00 

Salesmen's  Traveling  Expenses 

6,420.00 

Rent — ^Warehouse 

1,800.00 

Insurance — Warehouse  Stock 

2,280.00 

Pump  Jacks  Sales 

284,080.00 

Pump  Jacks  Return  Sales  and  Allowances 

7,700.00 

Engineers'  Supplies,  Sales 

80,810.00 

Engineers'  Supplies,  Return  Sales  and  Allow- 

ances 

2,820.00 

Engineers'  Supplies,  Purchases 

54,100.00 

OflSce  Salaries 

9,000.00 

Stationery  and  Printing 

550-00 

Postage 

840.0c 

Miscellaneous  OfiSce  Expense 

620.0c 

Rent— Office  Building 

1,200.00 

Legal  Expense 

500.00 

Bad  Debts  Written  Off 
Interest 

660.00 
1,840.00 

Discoimt  on  Sales 

5,460.00 

Discount  on  Purchases 

3,520.00 

729,870.00 

729,870.00 

COST  ACCOUNTS,  TYPES  OF  COST  ACCOUNTING      431 


Close  the  books,  taking  into  consideration  the  following: 
Unexpired  Insvirance  —  Factory  Building  and  Stock 
Unexpired  Insurance  —  Warehouse  Stock 
Accrued  Taxes  Estimated 
Accrued  Interest  on  Notes  Payable 
Accrued  Interest  on  Notes  Receivable 
Inventories,  June  30,  1908: 

Raw  Material 

Goods  in  Process 

Pump  Jacks  (Finished  Goods) 

Engineers'  Supplies 


640.00 
940.00 
600.00 
560.00 
300.00 

28,240.00 
17,820.00 
46,640.00 
27,320.00 

The  cartage  and  stable  expense  and  depreciation  on  horses  and  wagons 
to  be  charged  one  half  to  Manufacturing  and  one  half  to  Selling  account. 
The  taxes  are  to  be  charged  three  fourths  to  manufacturing  and  one  fourth 
to  profit  and  loss. 

Create,  reserve  for  depreciation  on  buildings  at  the  rate  of  5  per  cent  per 
annimi,  on  the  original  valuation. 

Create  reser\^e  for  depreciation  on  machinery  and  tools  at  the  rate  of  10 
per  cent  per  annum  on  the  diminishing  value. 

Write  oflf  depreciation  for  horses  and  wagons  at  the  rate  of  20  per  cent 
per  annimi. 

Write  off  depreciation  for  furniture  and  fixtures  at  the  rate  of  10  per 
cent  per  annimi. 

Patents  expire  10  years  from  January  i,  1908. 

Create  a  reserve  for  doubtful  accounts,  $1500.00. 

The  directors  declared  a  dividend  on  June  i,  1908,  of  5  per  cent  on  the 
outstanding  capital  stock,  payable  July  15,  1908,  for  which  no  entry  had 
been  made  on  the  books. 

Prepare  necessary  journal  entries  giving  effect  to  the  foregoing,  also  en- 
tries closing  the  books  through  the  manufacturing,  the  trading,  and  the 
profit  and  loss  accounts.  Make  a  manufacturing  account,  trading  ac- 
coimt,  profit  and  loss  account,  surplus  account,  and  balance  sheet. 
Make  all  closings  through  the  journal. 

12.  A  foimdry  produced  annually  a  large  output  of  cast  iron  lamp  posts 
of  a  given  dimension.  The  operations  involved  included  (i)  preparation  of 
metal  for  molding,  (2)  moulding,  and  (3)  clipping  and  finishing.  The  es- 
timated unit  cost  of  the  lamp  posts  was  as  follows: 


Total 

Operation 
No.  I 

Operation 

No.  2 

Operation 
No.  3 

Direct  Labor 

Material 

Indirect  Expense    .... 

1-75 
5.00 

1-25 

•SO 

4.00 

•65 

1. 00 

1. 00 

.40 

•25 
.20 

Totals 

8.00 

S-iS 

2.40 

•45 

432  ACCOUNTING  PRINCIPLES 

(a)  In  the  month  of  Januar>%  1921,  the  foundry  produced  5006  fimshed 
lamp  posts  and  put  500  others  through  Operation  No.  i,  and  300  through 
Operation  No.  2.  There  were  sold  during  the  month  4000  lamp  posts  on 
60  days'  time  at  $12.00  each.  The  financial  records  showed  the  following 
expenditures: 

Direct  Labor  $10,000.00 

Materials  28,000.00 

Indirect  Expense  '  6,500.00 

Make  out  the  following  accounts  on  the  basis  of  the  estimated  data: 
(i)  direct  labor,  (2)  materials,  (3)  indirect  expense,  (4)  finished  stock, 
(5)  cost  of  goods  sold,  (6)  sales,  (7)  profit  and  loss,  assuming  that  sales 
expense  is  5  per  cent  of  factor^'  cost. 

(b)  In  the  month  of  February-  the  output  was  7000  lamp  posts  and  the 
sales  at  the  same  price  were  $7,500.00.  At  the  end  of  Februar>'  there  were 
on  hand  500  of  finished  stock,  600  items  finished  through  Operation  No.  i , 
and  400  finished  through  Operation  No.  2.  During  the  month  of  February 
the  increases  in  the  three  financial  account  balances  were  as  follows: 

Direct  Labor  $12,500.00 

Material  38,000.00 

Indirect  Expense  9,000.00 

Make  out  the  same  accoimts  for  the  two  months  together  on  the  basis 
of  the  estimated  cost  data  as  those  made  out  in  (a)  above. 

(c)  ReWse  the  unit  cost  data  on  the  basis  of  the  financial  records. 

(d)  ^lake  a  corrected  journal  and  ledger  closing  for  the  several  accounts 
involved  in  (a)  and  (b)  and  also  a  re\-ised  set  of  unit  costs. 


CHAPTER  XXXI 
THE  MANUFACTURING  PROFIT  AND  LOSS  STATEMENT 

I.  Comparison  of  Manufacturing  Statement  to  Trading 
Statement.  —  The  uses  of  a  profit  and  loss  statement  of  a 
manufacturing  business  and  those  of  a  trading  statement  for  a 
mercantile  business  are  similar  in  character.  The  manufactur- 
ing business  frequently  does  also  a  trading  business  in  addition 
to  the  production  of  goods.  It  may  not  sell  its  products  to  the 
final  consumer  and  consequently  may  have  only  a  small  trad- 
ing organization.  The  trading  section  of  the  profit  and  loss 
statement  of  a  manufacturing  business  is  essentially  the  same 
as  the  revenue  statement  of  a  trading  business.  The  treatment 
of  a  manufacturing  statement,  therefore,  is  concerned  mainly 
with  the  treatment  of  that  section  of  the  statement  involved 
in  the  explanation  of  manufacturing  costs.  A  successful  oper- 
ation of  a  factory  from  the  standpoint  of  the  production  of  a 
high  grade  product  at  a  low  cost  would  not,  necessarily,  insure 
a  successful  business.  If  the  provision  for  the  sale  of  the  prod- 
uct were  unsatisfactory,  the  concern  might  fail  either  by  reason 
of  manufacturing  the  wrong  product  or  by  reason  of  inefficient 
methods  of  selling  the  product  which  has  been  produced. 
Moreover,  the  management  of  a  factory  is  frequently  committed 
to  a  superintendent  and  his  advisory  staff  with  only  a  very 
general  supervision  from  the  financial  and  selling  organization. 
It  is  possible,  therefore,  to  make  the  statement  of  the  results 
of  operation  so  far  as  factory  production  is  concerned  somewhat 
distinct  from  the  profit  and  loss  aspect  of  the  business  opera- 
tions. Factory  production  is  unsuccessful  in  carrying  out  the 
production  of  a  product  in  accord  with  specification  unless  this 
production  is  carried  out  at  a  reasonable  cost.  It  might  be  en- 
tirely successful  from  the  standpoint  of  the  factory  manager 

433 


434  ACCOUNTING  PRINCIPLES 

without  the  product's  being  sold  at  a  profit.  In  the  profit  and 
loss  statement  of  the  factory,  therefore,  the  question  of  unit 
costs  of  production  becomes  an  important  item  of  information. 
The  manufacturing  section  of  a  profit  and  loss  statement  will 
possibly  secure  better  results  if  it  is  made  preliminary  to  the 
trading  profit  and  loss  statement  instead  of  being  thrown  into 
the  trading  statement  as  a  subhead.  Ordinarily  the  first  step 
in  the  formation  of  a  trading  statement  would  be  to  make  the 
profit  and  loss  statement  for  the  period  under  consideration. 
The  interpretation  of  this  statement  might  then  require  addi- 
tional information  and  comparative  data.  The  following  form 
of  statement  will  serve  to  indicate  the  initial  draft  of  a  manu- 
facturing statement  which  would  serve  the  purposes  of  a  fac- 
tory relying  mainly  on  the  voucher  record  for  cost  data. 


ILLUSTRATION  NO.   35 

Form  for  Revenue  Statement  Manufacturing  and 
Merchandising  Business  Combined 

Manufacturing  Statement 

Prime  Cost 
Materials: 
Inventory  (Beginning)  .... 

Purchases                                              .... 
Deduct:  Returns  


Net  Purchases 
Add:  Freight-In 

Cost  Materials  Purchased 

Materials  to  be  Accounted  for 
Deduct:  Inventory  (End) 

Materials  Consumed 
Direct  Labor 

Total  Prime  Cost 


MANUFACTURING  PROFIT  AND  LOSS  STATEMENT    435 

Manufacturing  Expense 
Indirect  Labor  .... 

Factory  Supplies: 

Inventory  (Beginning)  .... 

Purchases  .... 


Total  Factory  Supplies 
Deduct:  Inventory  (End) 

Factory  Supplies  Consumed 
Repairs 

Heat,  Light  and  Power  (Factory) 
Taxes  —  Factory 
Insurance  —  Factory 
Depreciation  on: 

Factory  Buildings 

Factory  Fixtures 

Machinery  and  Tools 

Patents,  etc. 

Miscellaneous  Factory  Expense 
(All  other  items  of  factory  expense 
are  treated  similarly.) 

Total  Manufactimng  Expense 


Total  Manufacturing  Cost 

Add:  Inventory  Goods  in  Process  (Beginning) 

Total 

Deduct :  Inventory  Goods  in  Process  (End) 

Manufacturing  Cost  of  Goods  Completed  ^ 

Trading  and  Profit  and  Loss  Statement 

Trading  Section 

Manufactured  Goods: 

Gross  Sales                                                       .... 
Deduct:  Returns  


*  This  form  can  be  adapted  with  variations  to  all  ordinary  manufacturing  businesses.  The 
items  listed  and  the  inventories  to  be  considered  will  vary,  but  the  principles  to  be  followed 
in  the  statement  form  are  unvarying. 


436  ACCOUNTING  PRINCIPLES 

Net  Sales 

Inventory  Completed  Goods  (Beginning) 

Cost  of  Goods  Manufactured 

(Brought  down)  — 

Total  Manufactured  Goods  to  be 

accounted  for  

Deduct:   Inventory  Completed  Goods 
(End) 


Cost  of  Manufactured  Goods  Sold 

Gross  Profit  on  Manufactured  Goods 
Purchased  Merchandise 
Class  one  (Furniture  or  whatever  sort  of  mer- 
chandise is  sold) 
Gross  Sales 
Deduct:  Returns 

Net  Sales 

Inventory  (Beginning) 
Purchases                                            .... 
Deduct:  Returns  


Net  Purchases 
Add  Freight-In 

Cost  of  Pxu-chases 


Total  (Furniture)  to  be  accounted  for 
Deduct:  Inventory  (End) 

Cost  of  (Fumitiu^)  Sold 

Gross  Profit  on  (Furniture) 
Class  two  (Carpets  or  whatever  sort  of 
merchandise  is  sold) 
Form  similar  to  above,  arriving  at 
Gross  Profit  on  (Carpets) 
Class  three  (Similar  form  for  each  class 
of  merchandise  sold) 

Total  Gross  Profit 
Deduct: 


MANUFACTURING  PROFIT  AND  LOSS  STATEMENT    437 

Gross  Profits  (Forward) 

Selling  Expenses  _  .... 

Salesmen's  Salaries 
Salesmen's  Traveling  Expenses 
Freight  and  Cartage  Out 
Advertising 

Heat,  Light  and  Power  (Store) 
Miscellaneous  Selling  Expense 
Delivery  Expenses: 

Operation  Auto  Truck  .... 

Operation  Wagon  Truck  .... 

Depreciation  on  Delivery  Equipment        


Total  Delivery  Expenses 
Credits  and  Collections 
Depreciation  on  Store  Fixtures 
Other  Selling  Costs 

Total  Selling  Expenses 

Profit  on  Selling 
Deduct: 
Administrative  Expense: 
Office  Salaries 
Stationery  and  Printing: 

Inventory  (Beginning) 

Purchases 

Total  to  be  accounted  for 
Deduct:  Inventory  (End)   . 

Stationery  and  Printing  Cost 
Miscellaneous  Office  Expense 
Heat,  Light  and  Power  (Oflace) 
Depreciation: 

Building 

Office  Equipment,  etc. 

Taxes  (Office  Building) 
Insurance  (Office  Building) 
General  Administrative  Expense 

Total  Administrative  Expense 

Profits  from  Operations 


438  ACCOUNTING  PRINCIPLES 

Profits  from  Operation  (Forward) 
Add: 
Other  Income  .... 

Interest  Earned  .... 

Discount  on  Purchases  

(Any  other  income) 
Total  Other  Income  

Total  Income  

Deductions  from  Income 
Interest  Expense  .... 

Discount  on  Sales  .... 

Total  Deductions  from  Income                                           .... 
Net  Profit  for  the  Period  ^  

2.  Sections  of  the  Statement.  —  The  first  section  of  the 
manufacturing  statement  is  that  having  to  do  with  prime  cost. 
This  data  is  perhaps  the  most  important  from  the  standpoint 
of  judging  the  efl&ciency  of  the  labor  force  of  a  factory.  Statis- 
tical information  made  up  on  the  basis  of  the  prime  cost  figures 
would  show  the  vmit  cost  of  production  for  the  several  items  of 
prime  cost  if  the  output  consisted  of  a  uniform  product.  There 
would  ordinarily  be  a  specification  prime  cost  or  an  estimated 
prime  cost  which  could  be  compared  with  the  actual  cost  data 
taken  from  the  profit  and  loss  statement.  The  results  for  the 
period  would  indicate  the  degree  of  efl5ciency  with  which  the 
factory  had  been  operating  so  far  as  the  direct  labor  engaged  in 
manufacture  is  concerned  and  so  far  as  economy  in  the  pur- 
chase and  use  of  material  is  concerned.  There  is  ordinarily  less 
uniformity  in  the  indirect  expenses  of  a  factory  than  would  be 
found  in  the  direct  costs  of  production.  The  indirect  expenses 
are  likely  to  vary  less  with  the  total  output  of  a  factory  than 
would  the  direct  or  operating  expenses.  An  estimated  cost  of 
factory  production,  however,  would  also  involve  an  estimated 

>  The  statement  may  be  closed  at  this  point,  or  it  may  be  followed  by  the  surplus  state- 
ment showing  the  distribution  of  the  profit.  Sometimes  the  unusual  gains  are  added  and  the 
unusual  losses  deducted,  arriving  at  the  amount  which  is  to  be  carried  to  siuplus.  The  sur- 
plus statement  then  shows  the  distribution  of  the  profits. 


MANUFACTURING    PROFIT  AND  LOSS   STATEMENT     439 

indirect  expense  cost  per  unit  of  output,  and  the  indirect  or 
manufacturing  expense  section  would  serve  the  purpose  of  in- 
dicating the  extent  to  which  the  actual  cost  had  kept  within 
the  estimated  cost.  Likewise  each  account  of  manufacturing 
expense  would  be  subject  to  estimate  and  it  would  be  possible 
to  discover  by  an  analysis  such  as  that  shown  in  the  statement 
w^hich  of  the  items  of  indirect  expense  had  been  larger  than  the 
estimate  or  smaller  than  the  estimate.  No  statement  of  costs 
can  have  great  value  to  one  who  does  not  have  in  mind  stand- 
ard costs  with  which  to  compare  actual  costs. 

3.  Standard  Costs.  —  One  of  the  important  functions  of  fac- 
tory management  is  to  set  up  standard  costs  of  production  for 
a  factory  under  supervision.  Unless  these  standard  costs  can 
be  fairly  determined,  the  management  is  not  efficient.  The 
standard  costs  are  the  basis  upon  which  comparison  is  made 
with  results  of  a  given  period.  It  is  more  usual  to  set  up  esti- 
mated costs  as  a  standard  of  what  may  be  expected  than  in  any 
former  period  of  industrial  production.  Estimated  costs  are 
after  all  to  a  large  extent  the  basis  of  determining  the  cost  ac- 
counts which  are  to  be  set  up.  The  estimated  costs  are  conse- 
quently becoming  a  more  significant  part  of  the  manufacturing 
statement  than  in  any  previous  period  of  factory  production. 
The  actual  costs  of  production  from  period  to  period  are  of 
great  importance  in  making  an  estimate  of  the  probable  costs 
of  production  in  any  future  period.  Moreover,  a  reduction  in 
cost  in  a  given  period  as  compared  with  costs  in  a  preceding 
period  is  a  favorable  indication  in  regard  to  the  efficiency  of  a 
factory.  There  are  consequently  two  sets  of  data  which  are 
important  for  the  purpose  of  determining  the  significance  of  a 
statement  of  factory  production.  The  first  of  these  is  a  state- 
ment of  costs  in  a  preceding  period  and  the  second  is  the  esti- 
mate of  cost  which  was  made  at  the  beginning  of  the  period  in 
question.  Of  course,  unit  costs  are  important  both  in  connec- 
tion with  the  estimated  costs  and  the  actual  costs.  In  fact,  the 
estimate  frequently  takes  the  form  of  an  estimated  cost  per 
unit  in  the  first  instance.  The  following  form,  therefore,  of  a 
factory  statement  will  be  of  distinct  value  as  a  means  of  inter- 


440 


ACCOUNTING  PRINCIPLES 


preting  the  initial  statement  made  in  connection  with  closing 
the  books  for  a  period. 


ILLUSTRATION  NO.   36 

VALLEY  FURNITURE  (X)MPANY 

Manufacturing  Statement  (Comparative) 


Est. 
1920 

1 

Actual 
1920 

Per 

Unit 

Actual 
1919 

Per 

Unit 

Actual 
Increase 

1920  OVER 

1919 

' Increase 
PER  Unit 

I.  Prime  Cost 

a.  Materials  Used 

b.  Direct  Labor   . 

$.... 

$ 

$.... 

$ 

$.... 

$ 

1 

Total       .     . 

2.   Manufacturing  Exp.: 

a.  Indirect  Labor 

b.  Factory  Sup- 

plies   .    .    . 

c.  Repairs  Fac.  . 

d.  Heat  Light 

and  Power   . 

e.  Taxes   Factory 

f.  Depreciative 

Factory  .    . 

g.  Miscellaneous 

•••••■•■ 

Total  .     . 

3.   Total  Factory  Cost  . 

$.... 

S 

$.... 

$ 

$.... 

$ 

$ 

The  comparative  statement  of  the  trading  results  of  a  factory 
is  also  important  for  the  same  reasons  as  those  referred  to  in 
connection  with  factory  production.  It  would  therefore  be 
advisable  to  make  the  trading  statement  on  the  same  basis  as 
that  indicated  for  factory  production  when  a  comparative 
statement  is  made.  A  form  for  the  comparative  statement 
might  be  made  as  follows: 

I  It  is  only  possible  to  incorporate  the  per  unit  data  when  the  factory  is  sufficiently  spe- 
cialized so  that  accounts  can  be  set  up  on  this  basis. 


MANUFACTURING  PROFIT  AND   LOSS  STATEMENT     441 


COMPARATIVE  STATEMENT  OF  PROFIT  AND  LOSS  OF  VALLEY  FURNITURE 

COMPANY 

Showing  Merchandise  Sales 


Est. 
1920 

Est. 

PER 

Unit 

Ac- 
tual 
1920 

Ac- 
tual 

PER 

Unit 

Ac- 
tual 
1919 

Ac- 
tual 

PER 

Unit 

Actual 

Increase 

1920  over 

1919 

•In- 
crease 
per  Unit 

1.  Net  Sales  —  Carpets  .     .     . 

2.  Cost  of  Goods  Sold  —  Car- 

pets     

«... 

$.... 

$.... 

$ 

3.  Gross  Profits  —  Carjjets  .     . 

4.  Net  Sales  —  Chairs     .     .     . 

S.  Mfg.  Cost  —  Chairs    .     .     . 

6.  Gross  Profits  —  Chairs    .     . 

7.  Net  Sales  —  Furniture     .     . 

7.  Cost  of  Goods  Sold  — Fur. 

9.  Gross  Profits  —  Fur.  .    .     . 

10.  Total  Gross  Profits      .     .     . 

(3)  —  (6)  -  (9) 
II.  Selling  Expenses: 

a.  Salesmen's  Salaries 

b.  Salesmen's  Trav.  Exp. 

d.  Advertising     .... 

e.  Heat,  Light  and  Power 

(Store)    

f.  Del.  Exp.  and  Frt.    .     . 

g.  Del.  Exp.  Wagon  Frt. 

i.    Creditors  and  Collect- 
ors       

j.    Dep.  on  St.  Fixtures 

k.  Other  Selling  Exp.  .     . 

Total     .... 

12.  Profit  on  Selhng      .... 

13.  Adm.  Exp.: 

a.  Office  Sal.       .     .... 

c.  Heat,  Light  and  Power 

—  Office      .... 

d.  Deprec.  —  (Adm.  As- 

sets)   

e.  Taxes — (Adm.  Assets) 

f .   Insurance  — (  Adm.  As- 
sets)   

Total 

IS-  Other  Income: 

a.   Interest  Earned        .     . 

b.  Discount  on  Purchases 

c.   Miscellaneous 

Total 

16.  Total  Income 

17.  Deductions: 

a.  Int.  Exp 

b.  Discount  on  Sales    .     . 

18.  Net  Profits 

$... 

$.... 

$.... 

$.... 

8... 

$.... 

$ 

s 

'  It  might  not  be  feasible  to  carry  the  per  unit  columns  unless  the  sales  and  expenses 
could  be  classified  by  commodities. 


442  ACCOUNTING   PRINCIPLES 

4.  General  Administration  and  Cost  Data.  —  The  manufac- 
turing profit  and  loss  statement  is  of  use  mainly  to  the  general 
administrative  ofiicers  of  a  business.  It  has  a  significance  to 
the  subordinate  operating  ofiicers,  but  it  is  more  important  as 
a  means  of  control  from  the  standpoint  of  the  officers  in  charge 
of  the  business  as  a  whole.  The  manufacturing  statement  is 
commonly  made  once  each  month.  The  general  administrative 
officers  devote  their  attention  more  to  questions  of  planning 
and  matters  of  method,  specification  costs,  and  similar  general 
considerations  rather  than  to  the  detail  operating  facts  of  the 
factory.  On  the  basis  of  the  profit  and  loss  statement,  together 
with  a  balance  sheet,  the  factory  manager  or  officer  in  charge 
of  production  might  estimate  what  commodities  should  be 
produced,  and  could  in  addition  set  up  estimated  costs  of  pro- 
duction on  the  basis  of  the  specifications  involved  in  the  given 
case.  This  program  of  production  together  with  estimated 
costs  would  be  the  basis  of  a  program  of  purchase  of  raw  ma- 
terials and  a  program  of  employment  of  labor.  The  general 
officers  of  a  business  charged  with  the  employment  of  labor 
and  with  the  purchase  of  material  would  be  guided  in  their 
program  of  administration  by  the  production  estimate  made 
by  the  officers  in  charge  of  production.  The  officer  in  charge 
of  financing  production  must  likewise  rely  in  the  first  instance 
upon  the  statement  of  the  financial  condition  of  the  business  at 
the  beginning  of  the  period  and  secondly  upon  the  requirements 
of  the  program  for  production  that  may  be  adopted.  The  esti- 
mate of  the  financial  requirements  connected  with  any  produc- 
tion program  has  already  been  discussed  in  a  preceding  chap- 
ter on  the  profit  and  loss  statement.  One  cannot,  however, 
possibly  understand  the  significance  of  the  profit  and  loss 
statement  for  a  factory  unless  it  is  understood  that  its  content 
must  be  such  as  to  provide  adequate  information  for  the  prep- 
aration of  a  general  plan  of  production,  the  preparation  of  a 
general  plan  of  financing,  and  a  general  plan  of  employment. 
The  plan  of  production,  however,  must  itself  be  based  upon  the 
sales  estimate  made  by  the  selling  organization  of  a  business. 
The  factory  might  produce  goods  in  accordance  with  its  estimate 


MANUFACTURING  PROFIT  AND  LOSS  STATEMENT     443 

and  carry  out  a  program  completely  in  every  respect  except  in 
connection  with  selling  the  product  of  the  factory.  This  one 
deficiency  would  defeat  the  entire  aim  of  the  business  and  the 
entire  aim  of  factory  production.  The  estimate  as  to  the  sales 
possibilities  of  a  business  must  be  satisfactory  before  the  results 
of  production  can  be  fairly  forecasted.  The  detail  of  relating 
the  profit  and  loss  statement  to  the  financial  requirements  of  a 
business  would  be  substantially  the  same  in  factory  production  as 
in  the  case  of  the  trading  concern  discussed  in  a  previous  chapter. 

5.  Operating  Data.  —  For  operating  data  officers  and  fore- 
men of  a  factory  rely  rather  upon  a  detail  plan  of  production 
which  is  based  upon  the  general  plan  referred  to  in  the  para- 
graph above.  The  superintendent  of  a  factory  or  the  assistant 
superintendent  must  present  a  plan  of  production  for  each  day. 
This  plan  involves  production  orders  going  to  the  several  de- 
partments of  the  factory  and  these  production  orders  should  set 
forth  both  what  is  to  be  produced,  the  specifications  for  pro- 
duction and  the  time  limits  within  which  production  is  expected 
to  take  place.  There  will  consequently  arise  certain  day  to 
day  operating  reports  in  regard  to  the  daily  output  and  the  ex- 
penditure on  direct  labor  for  certain  operations,  and  reports 
must  be  made  from  day  to  day  showing  these  results  so  that 
the  work  of  a  succeeding  day  may  be  planned  and  provision 
may  be  made  for  carrying  out  the  general  program.  If  the 
actual  results  of  operation  are  not  made  known  from  day  to 
day  to  the  operating  foreman  and  officers  so  that  they  know 
substantially  how  actual  results  compare  with  estimated  re- 
sults, there  are  probably  defects  in  the  management  of  the 
business.  The  monthly  statement  will  doubtless  show  the  gen- 
eral results  of  operations  with  greater  accuracy  than  they  are 
known  by  the  operating  officials  prior  to  the  expiration  of  the 
month,  but  the  daily  and  weekly  reports  to  operating  execu- 
tives should  be  sufficient  to  enable  them  to  forecast  with  a  fair 
degree  of  accuracy  the  results  of  operation  for  the  longer  period. 

6.  Manufacturing  Budget.  —  The  manufacturing  budget  is  a 
systematic  statement  of  the  financial  requirements  of  a  factory 
for  a  given  period.    This  budget  must  be  based  upon  a  program 


444  ACCOUNTING  PRINCIPLES 

of  production  similar  to  that  referred  to  in  describing  the  uses 
of  the  comparative  statement  in  the  paragraph  above.  The 
expense  accounts  found  in  the  revenue  statement  together 
with  the  income  accounts  with  which  they  are  associated,  rep- 
resent the  framework  for  the  construction  of  a  budget.  If  the 
sales  for  a  period  can  be  estimated  with  a  degree  of  accuracy 
the  production  requirements  can  then  be  set  up  by  the  man- 
agement of  a  factory.  The  sales  program  and  the  production 
program  together  will  then  be  the  basis  of  determining  the  fi- 
nancial requirements  for  the  period  concerned.  An  estimated 
revenue  statement  for  a  period  together  with  a  balance  sheet 
at  the  beginning  of  the  period  would  serve  the  financial  man- 
agement of  a  factory  in  determining  the  funds  to  be  required 
for  a  given  period.  The  detailed  calculation  involved  would  be 
similar  to  that  discussed  in  connection  with  the  interpretation 
of  the  revenue  statement  for  a  trading  concern. 

7.  Budgetary  Accounts.  —  In  the  small  business  the  esti- 
mated costs  are  generally  treated  as  statistical  data  to  be  set 
up  in  comparison  with  actual  cost  data  that  results  from  a 
given  period  of  operation.  In  the  large  business,  however,  it  is 
frequently  regarded  as  desirable  to  set  up  the  budgetary  pro- 
gram in  the  accounts  of  the  concern.  The  oil  refining  business, 
for  example,  frequently  appropriates  for  a  given  period  a  cer- 
tain sum  of  money  for  a  distributing  station  at  a  certain  point. 
A  journal  entry  is  made  of  this  appropriation  in  the  same  way 
that  a  journal  entry  would  be  made  in  connection  with  munici- 
pal accounting  when  an  appropriation  is  made  for  the  opera- 
tion of  the  street  department.  If  the  distributing  station  were 
to  be  built  from  accumulated  surplus  an  appropriation  therefor 
might  be  made  by  the  following  journal  entries: 

a.  Station  A  Fund 

Cash _; 

Set  aside  funds  for  construction  of  Station  A 

b.  Surplus     

Station  A  Appropriation 

Charging  surplrs  with  appropriation 
for  construction. 


MANUFACTURING  PROFIT  AND  LOSS  STATEMENT     445 

If  these  entries  were  made  the  specific  appropriation  accounts 
would  be  subsidiary  to  the  total  of  appropriations  for  improve- 
ments and  additions.  As  funds  were  spent  they  would  be 
charged  to  the  appropriation  account.  If  $1500.00  were  so 
spent  it  might  be  entered  as  follows: 

Station  A  Appropriation 1,500.00 

Station  A  Fund 1,500.00 

If  material  for  station  A  account  were  purchased  on  time  the 
journal  entry  would  be: 

Station  A  Appropriation 

Accounts  Payable,  Station  A _____^ 

(Individual  creditor) 

When  the  account  is  paid  the  payment  would  be  charged  to 
accounts  payable,  station  A,  and  credited  to  the  station  A 
fund.  When  the  job  has  been  finished  let  us  suppose  that  it 
cost  $15,000.00  when  the  appropriation  was  $18,000.00.  The 
following  entries  would  be  made: 

Plant  and  Property,  Station  A. . . .  15,000.00 

Appropriation,  Station  A 3,000.00 

Surplus 18,000.00 

Cash 3,000.00 

Station  A  Fund 3,000.00 

An  entry  of  this  form  does  little  more  than  to  set  up  a  fund 
and  a  reserve  from  surplus  accumulated  to  be  used  for  the  con- 
struction of  a  distributing  station. 

QUESTIONS  AND  PROBLEMS 

1.  What  is  the  use  of  the  statement  of  manufacturing  costs? 

2.  What  is  the  relation  between  factory  costs  and  business  profits? 

3.  (a)  What  are  the  standard  costs  which  are  significant  in  a  manufac- 
turing statement? 

(b)  What  is  the  relation  between  standard  costs  and  the  usefulness 
of  actual  costs? 

4.  Show  the  relations  between  the  following:   (a)  sales  program,  (b)  pro- 
duction program,  (c)  financial  program. 

5.  How  would  each  of  these  be  constructed? 


446  ACCOUNTIXG  PRINCIPLES 

6.  From  the  trial  balance  and  accounts  made  in  connection  with  exer- 
cise data  at  the  end  of  Chapter  XXX  make  out  a  manufacturing  statement. 

7.  The  GX  Oil  Co.  sqjpropriated  $25,000.00  for  the  construction  of 
Station  A,  Januar>'  i,  1921.  On  January  15  $5,000.00  of  brick  were  pur- 
chased for  the  job  and  pajTolls  for  direct  labor  amounting  to  $3,000.00  were 
paid.  January  31  the  balance  of  invoices  were  paid:  materials,  $10,000.00; 
direct  labor,  $5,000.00;  indirect  expense,  $2,000.00.  The  work  was  finished 
and  all  necessary  entries  were  made.  Joiunalize  the  data  and  show  how  all 
accounts  stood  at  the  dose  of  the  job. 


CHAPTER  XXXII 

THE  VOUCHER  RECORD   AND   THE  ESTIMATING   COST 
SYSTEM 

1.  Record  of  Expenditures.  —  The  variety  of  indirect  ex- 
penses is  larger  for  a  factory  than  for  a  simple  mercantile  con- 
cern. The  four-column  purchase  journal  used  in  previous  chap- 
ters would  be  insufficient  to  provide  for  the  classification  of  ex- 
penditures involved  in  even  a  comparatively  small  factory.  A 
voucher  register  is  frequently  substituted  for  the  purchase  jour- 
nal. An  example  of  such  a  book  of  original  entry  is  shown  in 
Illustration  No.  37  below. 

The  transactions  illustrated  are  for  an  establishment  which 
combines  the  furniture  business  with  the  manufacture  of  chairs, 
and  will  be  found  in  the  transactions  for  May  of  the  Valley 
Furniture  Company  at  the  end  of  Chapter  XXIV.  When  a 
voucher  record  is  used,  all  expenditures  are  included  in  it. 
Even  cash  outlays  are  entered  in  the  voucher  record  prior  to 
their  entry  in  the  cash  book.  The  expense  classification  is  pro- 
vided for  in  the  voucher  record  so  that  the  detail  posting  of 
charges  to  expense  accounts  is  eliminated  in  the  cash  book. 
The  advantage  of  the  many  columns  provided  for  in  the 
voucher  register  is  the  economy  achieved  in  posting.  It  is 
necessary  to  post  only  the  monthly  totals  of  items  charged  to 
the  several  expense  accounts.  There  is  a  limit,  however,  to 
the  number  of  columns  which  may  be  readily  used  in  an  ex- 
pense distribution.  A  sundry  column  is  consequently  provided 
to  take  care  of  those  expense  accounts  which  involve  a  com- 
paratively small  number  of  postings  for  each  account.  The 
form  for  closing  the  voucher  register  and  posting  the  totals  of 
the  columns  is  shown  in  the  illustration  (No.  37). 

2.  Vouchers.  —  The  form  of  a  voucher  suitable  for  the 
voucher  register  referred  to  in  paragraph  i  is  shown  in  lUustra- 

447 


448  ACCOUNTING  PRINCIPLES 

tion  No.  38.  The  front  of  the  voucher  is  used  for  Hsting  the 
separate  invoices  included  in  a  given  voucher  and  for  such  gen- 
eral descriptive  material  as  may  indicate  the  character  of  the 
expenditure.  The  back  of  the  voucher  is  ordinarily  used  for 
making  the  distribution  of  the  total  expenditure  to  the  sepa- 
rate accounts  to  be  charged.  If  the  factory  were  in  the  habit 
of  paying  its  bills  monthly,  unpaid  bills  could  be  assembled  in 
a  file  according  to  firms.  At  the  end  of  the  month  the  invoices 
for  a  given  firm  could  then  be  voucher ed  and  attached  to  the 
face  of  the  voucher.  The  voucher  could  then  be  folded  prop- 
erly and  placed  in  the  unpaid  voucher  file.  They  are  num- 
bered serially  and  filed  in  numerical  order.  They  are  com- 
monly entered  in  the  voucher  register  when  they  have  been 
thus  prepared,  after  having  been  duly  approved  for  pa>Tnent 
by  the  appropriate  oflScers  of  the  business.  At  the  time  pay- 
ment is  made,  the  original  voucher  and  attached  bills  are  sent 
to  the  payee  to  be  receipted  and  returned.  The  payment 
would  be  entered  in  the  cash  book  opposite  the  appropriate 
check  number,  and  the  gross  amount  of  the  voucher  carried 
over  into  the  vouchers  payable  column.  The  cash  discounts 
could  then  be  treated  as  they  have  been  in  the  columnar  cash 
book  for  the  February  and  March  entries.  The  discount  col- 
umn in  the  voucher  register  is  used  for  statistical  purposes  only. 
The  postings  to  discount  on  purchases  account  and  discount 
on  sales  account  are  made  from  the  columnar  cash  book. 

Duplicates  of  respective  vouchers  are  frequently  also  filed 
by  the  clerk  in  charge  of  voucher  pa\Tnents  in  order  to  preserve 
the  voucher  memorandum  for  such  original  vouchers  as  the 
payees  may  fail  to  return.  When  the  original  voucher  returns, 
it  is  filed  in  numerical  order  among  the  paid  vouchers.  If  the 
payee  does  not  require  for  his  own  purposes  the  invoices  cov- 
ered by  a  given  voucher,  the  invoices  may  be  attached  to  the 
duplicate  voucher  and  held  for  reference  in  the  file  for  dupli- 
cate vouchers.  This  might  serve  in  some  instances  instead  of 
the  detail  copy  of  bills  made  by  business  houses. 

The  management  cannot,  however,  conveniently  refer  to 
vouchers  by  number  unless  they  have  an  index  showing  the 


VOUCHER   RECORD   AND    ESTIMATING   COST   SYSTEM    449 

voucher  numbers  for  each  creditor  of  the  business.  Such  an 
alphabetical  classification  of  creditors  with  numbers  of  vouchers 
issued  to  each  will  readily  take  the  place  of  an  accounts  pay- 
able ledger,  and  make  unnecessary  all  the  detail  postings  to 
the  credit  and  debit  of  purchase  ledger  accounts. 

3.  Voucher  Checks.  — ^  If  a  firm  wishes  to  assure  the  re- 
turn of  the  receipted  vouchers,  it  can  do  so  by  the  use  of  what 
is  called  a  voucher  check.  A  voucher  check  suitable  for  the 
firm  referred  to  in  Illustration  No.  38  is  shown  in  Illustration 
No.  39  below.  The  accounts  to  be  charged  are  shown  on  the 
face  of  the  voucher,  and  one  fold  of  the  back  of  the  voucher 
serves  as  a  check,  while  the  other  fold  provides  space  for  en- 
dorsements. The  voucher  check  would  be  treated  in  the  same 
way  as  the  original  voucher  referred  to  above. 


450 


ACCOUNTIXG  PRINCIPLES 


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ILLUSTRATION  NO.  38.  —  VOUCHER  (Front) 

Valley,  111., 19 

THE  VALLEY  FURNITURE  COMPANY 
To  Dr. 


Date 

OF 
I.WOICE 

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ILLUSTRATION  NO.  38  (Back) 


CHECK  NO. 

VOUCHER  NO. 
Date 

AMOUNT  $ 

I9_ 

Name 

ACCOUNTS   TO   BE 
CHARGED 

Purchases: 

Material 

Furniture 

Carpets 

Labor: 

Direct 

Indirect 

Operation  of  Wagon  Truck 

Operation  of  Auto  Truck 

Mfg.  Expense: 

Repairs 

Heat,  Light,  and  Power 

Factory  Supplies      .     . 

■ 

Misc.  Factory  Expense 

SelUng  Expenses: 
Salesmen's  Salaries 

Traveling  Expenses 

Advertising     .... 

Misc.  Selling  Expense  . 

General  Expenses: 
Office  Salaries      .     .     . 

Stationery  and  Printing 

Misc.  Expense     .     .     . 

Freight-In       .     .     .     . 

1 
1 

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ACCOUNTmG  PRINCIPLES 


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VOUCHER  RECORD  AND   ESTIMATING  COST  SYSTEM     455 


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456  ACCOUNTIXG  PRINCIPLES 

4.  Voucher  Register  and  the  Purchase  Ledger.  —  Since  the 
voucher  index  and  the  voucher  file  take  the  place  of  a  purchase 
ledger,  the  question  arises  as  to  the  disposition  of  the  accounts 
payable  already  entered  on  the  subsidiarj-  purchase  ledger.  It 
will  be  necessary  to  issue  vouchers  covering  the  unpaid  balance 
of  each  of  these  accounts  and  enter  these  vouchers  in  the 
voucher  register.  It  will  not  be  necessar\-  to  charge  the  mer- 
chandise purchases  account  or  the  expense  accounts,  as  these 
will  have  been  charged  in  connection  with  the  original  entries. 
In  entering  the  vouchers  an  account  of  vouchers  payable  is 
automatically  credited  because  the  items  go  into  the  vouchers 
payable  column.  In  order,  therefore,  properly  to  allow  for  this 
change  the  follo\\'ing  journal  entry  is  required: 

Accounts  Payable  (old  accoiint)  

John  Doe  

Richard  Roe  

Vouchers  Payable  (new  account)  .... 

This  entry  wiU  serve  to  close  the  old  accounts  payable  account 
and  at  the  same  time  open  the  new  vouchers  payable  account. 
The  subsidiary  debits  to  John  Doe,  Richard  Roe,  etc.,  merely 
serve  to  close  the  subsidiary  accounts  payable  iji  the  purchase 
ledger  at  the  same  time  the  accounts  payable  controlling  ac- 
count is  closed  in  the  general  ledger.  After  entering  the  initial 
vouchers  in  the  voucher  register,  it  is  only  necessar>'  to  enter 
in  the  sundry  account  column  the  debit  to  accounts  payable 
and  no  entr}"^  in  the  general  journal  is  then  necessar>'. 

5.  Goods  in  Process.  —  If  one  relies  on  the  voucher  register 
alone  for  cost  records,  no  accurate  statement  can  be  made  in 
regard  to  work  in  process.  The  amount  of  work  in  process  is 
entirely  a  question  of  inventor\'  determination,  as  set  forth  in  a 
preceding  chapter.  Moreover,  one  cannot  estimate  accurately 
the  amount  of  labor  which  has  been  spent  on  materials  that  are 
partly  finished.  It  is  not  so  difficult  to  determine  by  inspection 
the  amount  of  materials  involved  in  work  in  process.  If  the 
amount  of  expenditure  for  labor  and  indirect  expense  is  to  be 
determined,  one  must  analyze  the  productive  process  involved 
into  operations  so  that  a  given  amount  of  wage  e.xpenditure 


VOUCHER  RECORD  AND   ESTIMATING  COST  SYSTEM      457 

with  a  corresponding  amount  of  indirect  expense  may  be  as- 
signed to  unfinished  stock  in  the  various  stages  of  completion. 
In  the  final  stages  of  costing  one  must  after  all  rely  largely 
upon  estimates  of  cost  rather  than  upon  actual  cost  records. 

6.  Limitations  of  the  Voucher  Register. : —  If  indirect  labor 
and  indirect  expense  were  a  comparatively  small  fraction  of  the 
total  cost  of  a  given  product,  the  voucher  record  distribution 
might  be  relied  upon  to  produce  results  sufl5ciently  accurate  for 
managerial  use,  but  for  the  more  involved  types  of  manufac- 
ture such  a  cost  accounting  program  would  be  unsatisfactory. 


CHAPTER  XXXin 

OPENING    THE    CORPORATION    BOOKS  FOR  APRIL  TRANS- 
ACTIONS 

I.  Organization  of  Corporation.  — The  Valley  Furniture  Co. 
is  incorporated  under  the  laws  of  the  State  of  Illinois  with  a 
capital  stock  of  $150,000.00,  divided  into  1500  shares  of  the 
par  value  of  $100.00  each.    The  subscription  list  is  as  follows: 

Frank  Williams  400  shares 

WzJter  Day  345  shares 

John  Sykes  100  shares 

Howard  Andrews  322  shares 

Clyde  Atkins  100  shares 

John  Robbins  100  shares 

Henry  Moran  90  shares 

George  Callaway  43  shares 

In  a  large  corporation  it  would  be  necessary  to  open  a  sub- 
scription ledger  which  would  be  subsidiary  to  the  controlling 
account  of  subscribers  in  the  general  ledger.  In  small  corpora- 
tions with  few  subscribers  the  subscription  record  could  easily 
be  kept  by  memorandum,  the  details  of  subscriptions  and  pay- 
ments being  entered  in  the  general  ledger  account  with  sub- 
scribers. For  purpose  of  practice  in  keeping  the  subsidiary 
ledger,  a  subscribers'  ledger  should  be  opened  in  this  set.  In 
the  journal  the  outside  columns  formerly  used  for  accounts 
payable  should  be  headed  Subscribers,  and  in  the  cash  book  the 
column  formerly  used  for  cash  sales  should  be  headed  Subscrib- 
ers. WTien  the  subscriptions  have  all  been  paid,  all  accounts  in 
the  subscribers'  ledger  and  the  controlling  account  with  sub- 
scribers in  the  general  ledger  will  be  in  balance. 

At  the  first  meeting  of  the  stockholders  Frank  Williams, 
Walter  Day,  John  Sykes,  Howard  Andrews,  and  Clyde  Atkins 
are  elected  directors.    At  the  meeting  of  the  directors  Frank 

458 


OPENING  THE  CORPORATION  BOOKS  FOR  APRIL     459 

Williams  is  elected  President,  Howard  Andrews  Vice-president, 
with  the  duty  of  managing  the  factory,  and  Walter  Day,  Secre- 
tary-Treasurer of  the  corporation. 

At  the  first  meeting  of  the  stockholders  Williams  and  Day 
present  the  balance  sheet  of  their  business  as  of  March  31. 

At  the  same  meeting  an  agreement  to  purchase  certain  as- 
sets from  Howard  Andrews  is  confirmed.  Howard  Andrews 
owns  a  completely  equipped  chair  factory.  The  corporation 
purchases  this  factory  at  an  appraised  value  as  follows: 

Land  12,500.00 

Buildings  22,000.00 

Tools  and  Machinery  12,000.00 

Factory  Fixtures  700.00 

The  land  and  buildings  are  subject  to  a  mortgage  in  favor  of 
the  Valley  Trust  Co.  of  $15,000  payable  March  31,  191 6,  with 
interest  at  6  per  cent,  payable  annually  on  March  31. 

At  the  same  time  an  agreement  to  purchase  a  patent  on  a 
type  of  rocking  chair  which  it  is  proposed  to  manufacture  is 
confirmed.  The  patent  is  owned  by  Clyde  Atkins  and  has  10 
years  yet  to  run.    The  purchase  price  is  $10,000.00. 

It  is  necessary  to  keep  a  stock  ledger  to  show  the  amount  of 
stock  held  by  each  shareholder.  No  individual  accounts  are 
kept  with  shareholders  in  the  general  ledger,  but  the  capital 
stock  account  serves  as  a  controlling  account  of  the  stock 
ledger.  The  form  of  the  stock  ledgers  is  specially  ruled  to 
provide  space  for  information  that  may  be  required,  but  the 
standard  form  of  ledger  account  can  be  easily  made  to  serve 
the  purpose.  The  form  of  the  stock  ledger  may  be  taken  from 
Dlustration  No.  32. 

When  the  certiiicates  of  stock  have  been  issued  by  the  secre- 
tary as  indicated  above,  the  proper  entries  are  made  directly 
in  the  stock  ledger. 

2.  Schedule  of  Accounts.  —  After  the  entries  necessary  to 
record  these  opening  transactions  have  been  made,  they  should 
be  posted.  For  convenience  the  list  of  ledger  accounts  to  be 
kept  is  given  below. 


460  ACCOUNTING  PRINCIPLES 

A.   Assets 

AC.    Current  Assets 

AC  I.  Valley  National  Bank 
AC2.  Petty  Cash 
AC3.  Notes  Receivable 

AC3.  I.  Notes  Receivable  Discoimted 
AC4.  Accounts  Receivable 

AC4.  I.  Reserve  for  Bad  Debts 
AC  5.   Furniture  Inventory 
AC6.   Carpet  Inventory 
AC7.   Material  Inventory 
ACS.  Accrued  Interest  Receivable 
AC9.   Scrap 
AW.  Working  Assets 

AW  I.   Factory  Supplies 
AW  2.  Notes  Receivable  Stock  Subscriptions 
AW3.   Subscribers 
AW4.   Deferred  Expense 
AW  5.  Advance  to  Salesmen 
AF.    Fixed  Assets 

AFi.   Store  Fixtures 

AFi.  I.  Depreciation  Reserve  Store  Fixtures 
AF2.   Office  Equipment 

AF2.  I.  Depreciation  Reserve  Equipment 
AF3.   Factory  Fixtures 

AF3.  I.  Depreciation  Res.  Factory  Fixtures 
AFs-   Machinery  and  Tools 

AF5.  I.  Depreciation  Res.  Mach.  and  Tools 
AF6.   Delivery  Equipment 

AF6.  I.  Depreciation  Res.  Del.  Equipment 
AF7.  Building  —  Factory 

AF7.  I.  Depreciation  Res.  Factory  Building 
I  AF8.   Building  —  Office 

AF8.  I.  Depreciation  Res.  Office  Building 
AF9.  Land 
AFio.  Patents 
AFi  I.   Goodwill 

L.    Liabilities 

LC.     Current  Liabilities 

LCi.  Notes  Payable 

LC2.  Vouchers  Payable 

LC3.  Accounts  Payable 

LC4.  Accrued  Interest  Payable 
LD.    Deferred  Income 


OPENING  THE  CORPORATION  BOOKS  FOR  APRIL     461 

LF.    Fixed  Liabilities 

LFi.  Mortgage  Payable 
P.       Proprietorship 

PC.     Capital  Stock 

PCi.  Unissued  Stock 
PS.   Surplus 


E.   Expense  Accounts 

EF.  Factory  Expenses 

EFi.   Material  Purchases 

EF2.   Frt.  and  Cartage  In  —  Material  Purchased 
EF3.  Direct  Labor 
EF4.  Indirect  Labor 

EF5.   Repairs  —  Factory  Building  and  Machinery 
EF6.   Heat,  Light  and  Power 
EF7.  Factory  Supplies 
EF8.   Miscellaneous  Factory  Expense 
EFq.  Depreciation  —  Factory 
EX.    Trading  Expense 
ETP.   Purchases 

ETPi.   Furniture  Purchases 

ETP  I.  I.  Furn.   Purchases  —  Re- 
turns and  Allowances 
ETP2.   Carpet  Purchases 

ETP 2.  I.  Carpet  Purchases  —  Re- 
turns and  Allowances 
ETP3.   Frt.  and  Cartage  In  —  Purchases 
ES.     Selling  Expenses 

ESi.   Operation  of  Auto  Truck 
ES2.  Operation  of  Wagon  Truck 
ES3.   Advertising 

ES4.   Salesmen's  Traveling  Expenses 
ES5.  Salesmen's  Salaries 
ES6.  Depreciation  on  Delivery  Equipment 
ED.    Administrative  Expense 
ED  I.   Office  Salaries 
ED  2.   Stationery  and  Printing 
ED3.   Miscellaneous  Adm.  Expense 

EG.  General  Expense 

EGi.  Interest  Expense 

EG2.   Discount 

EG3.   Depreciation  on  Store  Fixtures 

EG4.  Insurance 

EG5.  Miscellaneous  General  Expense 


462  ACCOUNTESTG  PRINCIPLES 

R.  Revenues 

RS.     Sales 

RSi.   Furniture  Sales 

RSi.  I.  Furniture   Sales  —  Returns  and  Al- 
lowances 
RS2.   Carpet  Sales 

RS2.  I.  Carpet  Sales  —  Returns  and  Allow- 
ances 
RS3.    Chair  Sales 

RS3.  I.  Chair  Sales  —  Returns  and    Allow- 
ances 
RN.    Other  Income 

RNi.  Interest  Income 
RN2.  Discoimt  on  Purchases 
C.   Closing  Accounts 

Ci.   Manufacturing 
C2.    Trading 
C3.     Selling 
C4.    Profit  and  Loss 

3.  Opening  the  Voucher  Register.  —  The  important  cnange 
in  the  books  kept  in  this  business  is  the  substitution  of  the 
voucher  register  for  the  purchase  register.  Instead  of  enter- 
ing all  bills  for  merchandise  purchased  in  the  purchase  register, 
vouchers  are  drawn  covering  these  bills  and  also  all  other  bills 
of  whatever  description,  and  these  vouchers  are  entered  in  the 
voucher  register.  Expense  items  w^hich  were  formerly  entered 
in  the  journal  may  now  be  entered  in  the  voucher  register. 

The  headings  of  the  colxmms  in  the  voucher  register  are  as 
follows: 

1.  \'oucher  Number 

2.  Date 

3.  Name 

4.  Detail 

5.  Date  Paid 
Money  Column  Number: 

1.  Accounts  Payable 

2.  Discoimt  on  Purchases 
3-4-5.  General  Heading  —  Purchases 

3.  Material 

4.  Furniture 

5.  Carpets 


OPENING  THE   CORPORATION  BOOKS  FOR  APRIL     463 

6-7.  General  Heading  —  Labor 

6.  Direct 

7.  Indirect 

8.  Operation  Wagon  Truck 

9.  Operation  Auto  Truck 

10-13.  General  Heading  —  Manufacturing  Expense: 

10.  Repairs 

11.  Heat,  Light  and  Power 

12.  Factory  Supplies 

13.  Miscellaneous  Factory  Exp)ense 
14-17.  General  Heading  —  Selling  Expenses 

14.  Salesmen's  Salaries 

15.  Traveling  Expenses 

16.  Advertising 

17.  Miscellaneous  Selling  Expenses 
18-20.  General  Heading  —  General  Expenses 

18.  Office  Salaries 

19.  Stationery  and  Printing 

20.  Miscellaneous  Expenses 

21.  Freight-In 

Explanation  Column:    Sundry  Accounts 

FoUo  Column 

Final  Money  Colimm:    General 

4.  The  Books  of  the  Valley  Furniture  Co.  Transactions  for 
April,  1914.  —  All  accounts  which  should  be  kept  in  the  gen- 
eral ledger  for  this  month  are  listed  in  Chapter  XXIV.  Use 
this  list  of  accounts  only.  Keep  the  sales  ledger  and  the  sub- 
scribers' ledger  posted  up  to  date.  Continue  the  note  regis- 
ters.   Draw  vouchers  for  all  outstanding  accounts  payable. 

April  2.  A  call  is  made  for  50  per  cent  of  the  subscription  to  stock. 
John  Robbins  and  Henry  Moran  send  in  checks.  George  Gallaway 
gives  his  note  at  15  days  with  interest  at  6  per  cent. 

A  contract  is  made  with  Soars,  Roduck  &  Co.  of  Chicago  to  take 
the  entire  output  of  the  chair  factory  upon  terms  designated  in  the 
contract. 

A  three-year  insurance  pohcy  is  taken  out  to  cover  the  factory 
buildings,  equipment,  and  materials  for  $23,000.00  at  a  cost  of 
$738.25,  Voucher  ^i  is  made  out  to  the  Brown  Bros.  Agency  for  this 
amount,  and  the  voucher  is  paid  at  once.  (Charge  insurance  in  the 
Sundry  column.) 

Lxunber  costing  $2,800.00  is  pvurchased  from  the  Valley  Mills; 


464  ACCOUNTING  PRINCIPLES 

terms,  regvdar.  (R^ular  means  in  this  business  2/10  net  30.) 
\'oucher  *2,  charge  materials. 

The  special  series  vouchers  made  for  outstanding  accoimts  payable 
are  paid. 

April  3.  Leather  costing  $1,200.00  is  pvu-chased  from  the  Borch 
Tannery;  terms,  regular.    (Voucher  #3;  charge  materials.) 

Miscellaneous  materials  are  purchased  from  the  Marshall- Wallace 
Hardware  Co.  for  $750.00.    Terms  n  30.    (Voucher  #4.) 

Machinery  is  purchased  from  the  United  Machine  Shops  for 
$4,200.00.  Terms,  n  10.  (Voucher  ^s;  charge  machinery,  etc.,  in 
Simdry  coliunn.) 

April  4.  Bought  for  cash  from  the  Power  House  Supply  Co. 
CV^oucher  #6): 

Oil  and  Waste  for  Engine  Room  24.30 

SuppUes  for  Shop  18.75 

SuppUes  for  office  18.20 

Paid  the  Comer  Book  Store  (Voucher  #7)  for  the  following: 
Record  Blanks  for  Office  27.30 

Time  Cards,  Etc.,  for  Factory  8.25 

Stationery  for  Salesmen  11.40 

Received  on  account  the  following: 

Bismarck  Hotel  100.00 

H.  R.  Scott  73  40 

A.  M.  Mastin  163.80 

Cash  sales  were  made  as  follows: 

Carpets  126.00 

Fumitvue  214.50 

(Note:  In  this  month  cash  sales  will  be  entered  in  the  cash 
book,  general  column  only.  No  entry  is  made  in  sales  register 
which  is  now  for  credit  sales  only.  Posting  is  direct  from  cash 
book  to  the  sales  accoimts.) 

April  5.  Advanced  to  Donald  Home  $100.00  (Voucher  #8)  and  to 
Blaine  Harris  $125.00  (Voucher  #9),  these  amoimts  to  be  used  by 
them  as  advances  from  which  to  pay  their  expenses  as  traveling 
salesmen. 

Paid  in  cash  (Voucher  *io)  a  bill  of  the  Power  House  Supply  Co., 
for  $189.40  for  overhauling  the  machinery  preparatory  to  starting 
the  plant.     (This  item  should  be  charged  to  machinery.) 

Received  bill  of  the  Valley  Press  (Voucher  *ii)  for  $397.00  for 
printing  catalogue.    The  bill  is  not  paid  at  this  time. 

April  6.    Purchases  as  follows: 


OPENING  THE   CORPORATION  BOOKS  FOR  APRIL     465 

Haywood  Furniture  Co.  —  Furniture  3,250.00 

Terms,  regular.    (Voucher  ^12) 
Wilson  Carpet  Co.  —  Carpets  1,728.00 

Terms,  regular.    (Voucher  fjii^) 
Receipts  on  account: 

Martindale  Furniture  Co.  325.00 

K.  C.  Riley  25.00 

J.  Collins  7S-00 

H.  P.  Square  Business  College  50.00 

Sales  on  account: 

Fulton  Furniture  Co.  —  Furniture  500.00 

Carpets  300.00 

Terms,  regular 

Randolph  Furniture  Co.  —  Furniture  325.00 

Carpets  700.00 

Terms,  regular 

April    7.      Purchased    from    Furniture    Emporium:     furniture, 
$1,200.00;  carpets,  $2,250.00;  terms,  regular  (Voucher  ^14). 

Receipts  on  account:     Smith  Institute,  check  for  $980.00;    dis. 
$20.00. 

Paid  the  Valley  Central  (Voucher  $15)  $3 15.00  freight  on  machin- 
ery purchased  April  3  (charge  to  machinery). 

Paid  the  Valley  Press  $200.00  (Voucher  ^16)  for  advertising  to  be 
run  during  April. 

April  9.    Bought  sundry  materials  from  the  Mahin  Leather  Sup- 
ply Co.  amounting  to  $2,543.00.    Terms,  regular.    (Voucher  ^17.) 

Paid  the  note  of  Limbert  &  Gray  Furniture  Co.  of  $1,800.00  with 
interest  of  $24.00.    (Voucher  ^18.) 

Voucher  ^  1 1  in  favor  of  the  Valley  Press  is  paid. 
Voucher  ^19  is  drawn  in  favor  of  James  Blackwell,  the  cashier,  for 
$57.40  to  replace  money  expended  from  the  petty  cash  fimd  as  fol- 
lows: 

Shop  Supplies  4.20 

Miscellaneous  Factory  Expense  2.60 

Advertising  3.00 

Stationery  and  Printing  5.00 

Miscellaneous  Office  Expense  12.45 

Operation  Auto  Truck  i7-7S 

Operation  Wagon  Truck  12.40 


57-40 
The  voucher  is  immediately  paid. 

Purchased  from  the  Stanley  Coal  Co.  (Voucher  #  20)  100  tons  coal 
at  $5.75.    The  bill  is  not  paid  at  this  time. 


466  ACCOUNTmC  PRINCIPLES 

H.  R.  Scott  pays  his  note  of  $428.00  due  today,  with  interest  of 

Receipts  on  account: 

Randolph  Furniture  Co.  —  check  1,176.00 

discount  24.00 

Foster  Hall  —  check  784.00 

discount  16.00 

April  II.  Voucher  *2  in  favor  of  the  Valley  Mills  is  paid  Face 
of  voucher,  $2,800.00;  discount,  $56.00. 

The  United  Machine  Shops  are  paid  $178.49  (Voucher  #21)  for 
labor  in  installing  machinery  purchased  on  April  3.  (Is  installation 
of  machinery  a  part  of  cost  of  machinery?) 

April  12.  Pay  Voucher  #3  in  favor  of  the  Borch  Tannery  for 
$1,200.00,  less  discount  of  $24.00. 

Pay  Voucher  *  5  in  favor  of  the  United  Machine  Shops  for  $4,200.00. 

Draw  and  pay  Voucher  #22  in  favor  of  the  Valley  Central  R.  R. 
or  $176.75,  Freight-In  on  purchases  to  date. 

April  13.    Collections  on  account: 

Fulton  Furniture  Co.  850.00 

St.  Luke's  Hospital  760.00 

The  first  shipment  of  chairs  is  made  to  the  Soars-Roduck  Co. ;  200 
chairs  are  sent  them  invoiced  at  $10.25  each,  terms  2/20,  net  30. 

April  14.    Cash  sales:    furniture,  $476.00;  carpets,  $327.00. 

Credit  Sales: 
J.  H.  Brigham:  fiuniture,  $420.00;   carjjets,  $271.00;    terms  regular. 
A.W.Martin:    furniture,  $625.00;   carjjets,  $1030.00;  terms  regvilar. 
H.  R.  Scott:       furniture,  $460.00;   carpets,  $320.00;    terms  regular. 

A  cash  refimd  is  made  to  John  Smith  (Voucher  *  2^)  for  a  defect 
in  a  carpet  bought  for  cash,  $25.00. 

April  15.  The  semi-monthly  payroll  is  paid  by  a  check  to  Cur- 
rency (Voucher  fH 24).    The  voucher  shows  the  following  distribution: 

Direct  Labor  1,037.40 

Indirect  Labor  483.00 

Heat,  Light  and  Power  65.00 

Salesmen's  Salaries  170.00 

Ofl&ce  Salaries  256.00 

Op)eration  Auto  Truck  35-oo 

Operation  Wagon  Truck  27.50 


2,073.90 


April  16.    The  George  Callaway  note  for  $2,150.00  taken  for  stock 
subscription  is  paid  today  through  the  bank  with  interest  of  $5.38. 


OPENING  THE  CORPORATION  BOOKS  FOR  APRIL     467 

Vouchers  ^s  12  and  13  in  favor  of  the  Haywood  Furniture  Co.  and 
the  Wilson  Carpet  Co.  are  paid,  the  discount  being  taken. 
Collections  on  account: 

Randolph  Furniture  Co.,  check,  $1,004.50;  discount,  $20.50. 
Fulton  Furniture  Co.,  check,  $784.00;  discount,  $16.00. 

April  18.  To  meet  current  obligations,  a  temporary  loan  is  made 
at  the  Valley  National  Bank  of  $4,000.00  for  30  days,  bank  discount 
of  $26.67  being  deducted  in  advance. 

Voucher  M 14  in  favor  of  the  Furniture  Emporiiun  is  paid,  discount 
$63.00. 

Voucher  *  25  is  drawn  in  favor  of  the  Power  House  Supply  Co.  for 
repairs  to  machinery  amounting  to  $41.23.    The  voucher  is  not  paid. 

Purchased  materials  amounting  to  $2,900.00  from  the  Valley  Mills. 
Terms,  regular.    (Voucher  ^  26.) 

April  19.    Cash  sales:    furniture,  $425.00;  carpets,  $231.00. 

Voucher  #17  in  favor  of  the  Mahin  Leather  Co.  is  paid;  discoimt 
$50.86. 

Voucher  #27  is  drawn  and  p)aid  to  the  Central  Garage  for  automo- 
bile supplies,  $31.50. 

April  20.  Collections  on  account:  Newsome  Furniture  Co., 
$1,500.00. 

The  Valley  National  Bank  notifies  the  Valley  Furniture  Co.  that 
the  Martindale  Furniture  Co.  note  due  today  has  been  paid. 

April  21.    Credit  Sales: 

J.  H.  Brigham  fum.,  $   425.00;  carpets,  $380.00;  terms,  reg. 

Randolph  Fum.  Co.  fum.,    1,840.00;  carj)ets,    760.00;  terms,  reg. 

Fulton  Fum.  Co.  fum.,    1,200.00;  carpets,    675.00;  terms,  reg. 

Newsome  Fum.  Co.  fum.,       950.00;  carpets,    780.00;  terms,  reg. 

April  23.  Purchased  from  the  Central  Furniture  Co.,  terms  regu- 
lar: 

fumiture,  $2,640.00;  carpets,  $1,230.00.    (Voucher  #28) 

The  Bismarck  Hotel  has  gone  into  bankruptcy.  The  amoimt  due. 
$250.00,  is  charged  to  Frank  Williams,  who  guaranteed  the  accoxmts 
receivable  transferred  to  the  corporation  by  Williams  and  Day. 

Collections  on  account: 

H.  R.  Scott  check,  $    764.40;  discount,  $15.60 

A.  W.  Martin         check,    1,621.90;  discoimt,    33.10 

April  25.  Voucher  #29  is  drawn  and  paid  to  R.  L.  White  for  ex- 
penses incurred  in  and  fees  for,  defending  suit  for  infringement  of 
patent  rights,  $100.00  (charge  to  patents). 


468  ACCOUNTING  PRINCIPLES 

Voucher  #30  is  drawn  in  favor  of  the  Smithson  Contract  Co.  for 
^i>335-oo  for  grading  the  factory  grounds  and  lav-ing  out  drives  and 
walks.    (Is  this  an  expense  or  an  addition  to  assets?) 

April  27.    Credit  Sales: 

A.  W.  Martin  furniture,  $   490.oo;carpets,  $300.00;  terms,  reg. 

H.  R.  Scott  furniture,    1,010.00;  carpets,    460.00;  terms,  reg. 

K.  C.  Riley  furniture,    1,725.00;  carpets,    760.00;  terms,  reg. 

April  28.  The  Valley  Mills  is  willing  to  allow  the  discoimt  on 
Voucher  *  26  if  payment  is  made  by  a  note  of  the  corporation.  A 
note  payable  in  30  da>'s  with  interest  at  6  per  cent  is  given  for  the 
net  amount  of  the  voucher.  (Mark  the  voucher  "  Paid  by  journal 
entry."  referring  to  page  on  which  the  entr>'  is  made,  and  make  the 
necessary  entry  in  the  journal.) 

Purchased  from  the  Borch  Tannery  materials  amoimting  to 
$2,160.00.    Terms,  n/30.    (Voucher  *3i.) 

Voucher  #32  is  drawn  and  jmid  to  James  Blackwell,  the  cashier,  for 
payments  from  petty  cash  as  follows: 


Shop  Supplies 

22.00 

Miscellaneous  Factory  Expense 

10.00 

Advertising 

320 

Miscellaneous  Selling  Exi>ense 

2.10 

Stationery  and  Printing 

1475 

Miscellaneous  Office  Expense 

730 

Operation  Wagon  Truck 

21.70 

81.05 

A  second  shipment  of  chairs  to  the  Soars-Roduck  Co.  is  made,  680 
chairs  being  sent,  billed  as  before. 

Allowance  is  made  for  damage  to  the  goods  sold  to  H.  R.  Scott  on 
the  27th:    furniture,  $16.00;  carpets,  $23.00. 

April  30.  Voucher  #35  to  currency  covers  the  semi-monthly  pay- 
roll as  follows: 

Direct  Labor  1,140.00 

Indirect  Labor  652.00 

Repairs  25.00 

Salesmen's  Salaries  170.00 

Operation  Auto  Trudc  3  5  00 

Office  Salaries  266.00 

Operation  Wagon  Truck  27.50 

2,315-50 


OPENING  THE  CORPORATION  BOOKS  FOR  APRIL     469 

The  following  vouchers  are  drawn  and  paid: 

Donald  Home,  salesmen's  salaries,  $125.00;  expenses,  $87.00; 
(Voucher  ^34.) 

Blaine  Harris,  salesmen's  salaries,  $110.00;  expenses,  $82.50. 
(Voucher  #35.) 

Frank  Williams,  salary  as  general  manager,  $200.00  (Voucher  #36.) 

5.  The  Record  of  April  Transactions.  —  After  entering  the 
April  transactions  the  student  should  close  the  books  of  orig- 
inal entry  first  with  pencil  closings.  Then  the  trial  balance  for 
the  April  transactions  should  be  taken.  After  the  transactions 
are  checked  and  a  correct  trial  balance  is  found  the  additional 
entries  should  be  made  from  the  succeeding  paragraph. 

6.  Additional  Summary  Entries.  —  To  provide  material  upon 
which  to  base  a  yearly  closing  for  the  business  of  the  Valley 
Furniture  Co.  without  making  necessary  routine  detailed  en- 
tries for  the  whole  period  the  transactions  between  May  i, 
1915,  and  March  31,  igi6,  are  given  below  in  total.  Enter 
these  totals  properly  in  the  books  of  the  Valley  Furniture  Co.; 
post  them,  and  take  a  trial  balance  as  of  March  31,  1916. 

VOUCHER  RECORD 


Material  Purchased        64,243.00 

Salesmen's  Trav.  Exp. 

1,468.40 

Furniture  Purchased      70,314.00 

Misc.  Selling  Exp. 

726.35 

Carpets  Purchased         48,372.00 

Advertising 

2,475.20 

Freight-In                          4,367-45 

Freight  Out 

675.28 

Direct  Labor                  33,460.45 

Office  Salaries 

8,342.00 

Indirect  Labor                13,748.90 

Stationery  and  Printing 

543-95 

Repairs  to  Machinery      1,136.27 

Misc.  Office  Exp. 

150-30 

Heat,  Light  and  Power    6,358.70 

Taxes 

1,340.54 

Factory  Supplies              1,428.40 

Interest 

1,143.27 

Misc.  Factory  Exp.              162.36 

Notes  Payable 

24,360.00 

Operation  Auto  Truck        954-85 

Advances  to  Salesmen 

200.00 

Operation  Wagon  Truck     746.63 

Salesmen's  Salaries 

5,640.00 

The  total  credit  to  accounts  payable  is  $292,358.30. 

SALES   RETURNS  AND   AL- 

SALES REGISTER 

LOWANCES 

Furniture  Sales             106,342.50 

Furniture 

1,100.60 

Carpet  Sales                   78,221.40 

Carpets 

627.30 

Chair  Sales                   126,347.29 

Chairs 

1,225.65 

470  ACCOUNTING  PRINCIPLES 

JOURNAL 

Accts.  Rec.,  $17,268-40  are  paid  by  notes. 

Notes  Rec.  Disc.,  $500.00  have  matured  without  protest. 

Bad  Debts  amounting  to  $251.00  are  charged  off. 


CASH  BOOK  DEBITS 

Collection  of  .\ccts.  Rec.  $276,543.20,  less  disc,  on  sales  $2,821^^3. 
Notes  Rec.  paid  up,  $13^36.40,  and  from  int.  $740.00. 
Notes  Rec.  Disc  $1,310.00  less  int.  of  $35.00. 
Notes  Pay.  $25^400.00  less  int.  of  $325.30. 


CASH  BOOK  CREDITS 
Accts.  Pay.  paid  $285,362.40,  less  disc,  on  pur.  of  $3,294.63. 

7.  Data  for  Annual  Closing.  —  A.  Adjustments  prior  to 
closing: 

(a)  Depreciation.  —  Allow  annual  depreciation  on  store  build- 
ing of  5  per  cent  and  on  factory  of  6  per  cent.  Allow  annual 
depreciation  on  machinery  and  tools  of  8  per  cent.  The  depre- 
dation on  these  classes  of  assets  should  be  shown  in  the  re- 
serve accounts  which  have  already  been  proNaded  for.  Write 
down  the  value  of  factory  fixtures,  store  fixtures,  and  oflSce 
equipment  10  per  cent  for  depreciation,  and  the  value  of  the 
delivery  equipment  20  per  cent  for  depreciation. 

(b)  Interest  Items.  —  Any  accrued  interest  on  notes  receiv- 
able or  accrued  interest  on  notes  paj'able  which  was  found  on 
the  books  at  the  beginning  of  the  period  should  be  dosed  out 
by  the  usual  reversing  entr>'  if  it  was  not  done  at  the  beginning 
of  the  period. 

(c)  Accrued  interest  on  notes  receivable  at  the  end  of  the 
year  was  $174.50.  Place  this  item  on  the  books.  Interest  paid 
in  advance  on  notes  pxayable  amounted  to  $45.00. 

(d)  Payroll  Payable.  —  There  was  direct  labor  accrued  of 
$795.40,  indirect  labor  of  $286.79,  3^nd  engineers'  and  firemen's 
salaries  of  S24.00.    (Open  pa>TolI  payable  on  page  58.) 

B.    Closing  entries: 


OPENING  THE  CORPORATION  BOOKS  FOR  APRIL     471 

(i)  Manufacturing  costs  are  shown  in  the  manufacturing  ac- 
count. This  account  is  debited  with  all  costs  of  manufacturing 
and  credited  with  all  off-sets,  so  that  when  all  entries  have  been 
made,  the  balance  in  the  account  represents  the  cost  of  manu- 
facturing the  goods  which  have  been  made  during  the  period. 
The  first  items  to  be  shown  in  this  account  are  the  elements  of 
prime  cost,  materials  and  direct  labor.  The  cost  of  materials 
used  in  manufacturing  is,  of  course,  the  inventory  of  materials 
at  the  beginning  of  the  period  plus  the  purchases,  less  the  in- 
ventory at  the  end. 

The  adjustments  for  inventory  can  be  made  either  in  mate- 
rial purchases  or  in  manufacturing.  The  first  entry  made  is 
that  to  transfer  to  material  purchases  the  proportionate  cost  of 
the  freight  on  materials  purchased.  Three  eighths  of  the 
freight- in  is  to  be  charged  to  materials.  The  inventory  of 
materials  is  $12,000. 

The  next  step  is  to  close  into  manufacturing  all  other  costs. 
The  elements  of  manufacturing  costs  in  addition  to  prime  cost 
which  are  found  in  this  business  include  indirect  labor,  used 
for  factory  operation,  factory  supplies,  miscellaneous  fac- 
tory expense,  depreciation  on  factory  and  equipment,  taxes 
and  insurance  on  factory  and  equipment.  Some  of  these 
items  can  be  transferred  directly  to  manufacturing.  Others 
require  adjustment.  There  is  an  inventory  of  factory  sup- 
plies of  $325.00.  (Adjust  the  account  to  show  the  cost  of  fac- 
tory supplies  consumed  before  closing  it  into  manufacturing.) 
Three  fourths  of  the  cost  of  heat,  light  and  power  was  for  the 
factory.  The  depreciation  on  factory  building,  machinery  and 
tools,  and  factory  fixtures  is  chargeable  to  manufacturing.  One 
half  of  the  taxes  was  for  the  factory  equipment  and  materials. 
The  insurance  expired  during  the  year  was  $434.60,  of  which  one 
half  was  insurance  on  the  factory  and  contents.  (The  simplest 
method  of  booking  this  cost  is  by  debiting  manufacturing  and 
crediting  insurance  with  the  proper  amount.)  Patents  should 
be  written  down  one  tenth,  as  their  value  has  decreased  by  at 
least  that  amount.  This  decrease  in  the  value  of  patents  is  a 
manufacturing  expense. 


472  ACCOUNTING  PRINCIPLES 

The  final  step  is  to  make  the  adjustment  in  manufacturing 
for  the  goods  in  process  so  that  the  account  will  show  the  cost 
of  the  actual  goods  completed.  This  adjustment  is  made  by 
transferring  any  inventory  of  goods  in  process  at  the  begin- 
ning of  the  period  to  manufacturing  (in  this  case  there  was  no 
such  inventor}'  since  the  factory-  began  operations  at  the  be- 
j  ginning  of  the  p>eriod)  and  placing  the  new  inventorj'  of  goods 

in  process  on  the  books.  This  inventory-  was  $10,290.00.  The 
Manufacturing  account  now  shows  the  cost  of  the  goods  which 
have  been  manufacttured. 

(2)  To  determine  gross  profits. 

The  gross  profits  are  to  be  determined  on  each  class  of  mer- 
chandise sold.  To  determine  the  gross  profits  on  chairs  it  is 
necessar\'  to  show  first  the  cost  of  manufacturing  the  chairs. 
The  cost  of  manufacturing  has  been  determined  in  manufac- 
turing. An  entry  transferring  this  cost  from  manufacturing  to 
trading  is  necessar>'.  The  principal  credit  is  of  course  the 
chair  sales,  and  this  account,  after  adjustment  for  returns,  is 
closed  into  trading.  When  the  account  is  adjusted  for  the  in- 
ventories, the  gross  profit  on  chair  sales  can  be  found.  There 
was  no  inventor}-  of  chairs  at  the  beginning  of  the  period,  but 
at  the  end  there  was  an  inventor}-^  of  finished  product,  chairs, 
of  $9,980.00.  In  order  that  the  gross  profit  may  be  shown 
dearly,  the  trading  account  should  be  balanced  at  this  point 

R  and  the  gross  profit  on  chair  sales  brought  down.      The  gross 

profit  on  furniture  sales  and  carjjet  sales  is  to  be  determined 
in  separate  trading  accounts. 

»  One  fourth  of  the  freight- in  is  to  be  charged  to  carpet  pur- 

chases and  three  eighths  to  furniture  purchases.  The  inventor}' 
of  carpets  at  the  end  of  the  year  was  $30,000.00  and  of 
furniture,  $59,000.00.  The  trading  account  now  shows  the 
gross  profit  on  all  classes  of  goods  sold. 

(3)  Selling  Costs.  —  A  selling  account  is  sometimes  opened 
either  as  a  separate  closing  accoimt  or  as  a  section  of  the  profit 
and  loss  account.  It  may  be  opened  as  a  separate  account. 
The  gross  profits  from  the  trading  accounts  would  be  brought 
down  to  the  credit  of  the  selling  account  by  journal  entry.     All 


OPENING  THE  CORPORATION  BOOKS  FOR  APRIL     473 

the  expense  accounts  classified  under  selling  expenses  in  the 
schedule  of  accounts  would  then  be  closed  into  selling  by  jour- 
nal entry. 

In  this  business  the  selling  costs  are  the  proportionate  amount 
of  heat,  light,  and  power  used  in  the  store,  which  was  one  eighth 
of  the  total  amount,  the  operation  of  the  auto  truck,  the  oper- 
ation of  the  wagon  truck,  the  depreciation  on  delivery  equip- 
ment (remember  that  during  the  year  a  charge  was  made  to  depre- 
ciation on  some  delivery  equipment,  which  must  be  added  to 
the  depreciation  allowed  at  the  end  of  the  year)  the  deprecia- 
tion on  store  fixtures,  salesmen's  salaries,  salesmen's  travel- 
ing expenses,  miscellaneous  selling  expense,  freight  and  cart- 
age out,  and  advertising.  $275.00  of  the  advertising  expen- 
diture is  to  be  treated  as  a  deferred  charge.  The  balance  in 
selling  now  shows  the  profit  on  selling  before  the  general  ex- 
penses of  the  business  are  deducted. 

(4)  Determining  the  Net  Profit.  —  The  net  profit  on  selling 
is  then  transferred  to  profit  and  loss,  in  which  account  the  va- 
rious general  expenses  of  the  business  are  deducted.  These 
general  expenses  include  office  salaries,  stationery  and  print- 
ing (before  closing  this  account  must  be  adjusted  for  an  inven- 
tory of  $25.00  of  office  supplies  on  hand),  miscellaneous  office 
expense,  depreciation  on  store  building  and  on  office  equip- 
ment, one  eighth  of  the  total  cost  of  heat,  light,  and  power,  and 
one  half  of  the  taxes  and  one  half  of  the  insurance.  The  balance 
in  profit  and  loss  at  this  point  is  the  net  profit  from  operations. 
The  account  should  be  balanced  and  the  net  profits  from  oper- 
ation shown.  To  this  net  profit  from  operations  is  to  be  added  the 
secondary  income,  and  the  deductions  from  income  are  the  dis- 
count accounts.  A  reserve  for  uncollectible  accounts  is  to  be 
set  up  by  debiting  profit  and  loss  and  crediting  reserve  for  bad 
debts.  Allow  $750.00  for  this  item.  Against  this  reserve  charge 
the  uncollectible  accounts  as  they  are  marked  off. 

The  balance  in  profit  and  loss  now  shows  the  net  profit  for 
the  year.  The  accounts  are  now  in  such  condition  that  the 
final  statements  can  easily  be  made. 

(5)  Form  for  a  Sectionalized  Profit  and  Loss  Account,  —  The 


474 


ACCOUNTING  PRINCIPLES 


Student  will  readily  see  just  what  journal  entries  are  made  from 
the  following  form  for  a  sectionalized  profit  and  loss: 

ILLUSTRATION  NO.  40 
Profit  and  Loss  (Sectionalized) 


Operation  of  Auto  Truck 

Operation  of  Wagon  Truck 

Advertising 

Salesmen's  Trav.  Expense 

Salesmen's  Salaries 

Depreciation    on    Delivery 

Equipment 
Net  Profit  on  Selling 


Gross  Profits  (down) 


Office  Salaries 
Stationery  and  Printing 
Depreciation  on  Stores  and 

Fixtures 
Insurance 

Misc.  General  Expense 
Net  Profit  from  Operation 


Net  Profits  on  Selling 
(down) 


Discount  on  Sales 
Interest  Expense 
Net  Profits 


Net  Profits  from  Opera- 
tion (down) 
Interest  Income 
Discount  on  Purchases 


APPENDIX 
THE  WORKING  SHEET 

1.  The  Purpose  of  the  Working  Sheet.  —  When  the  closing 
is  made  by  journal  entry,  the  whole  process  involves  several 
accounts,  the  balance  sheet,  and  revenue  statement.  The 
accountant  frequently  wishes  to  bring  all  of  these  together 
on  the  same  page,  for  the  purpose  of  working  out  the  data  in 
the  first  instance  prior  to  placing  it  on  the  ledger.  The  old 
elementary  text  furnished  for  this  purpose  what  was  called  the 
six-column  statement.  This  statement  had  in  it  the  following 
columns:  (a)  Trial  balance  debits;  (b)  Trial  balance  credits; 
(c)  Profit  and  loss  debits;  (d)  Profit  and  loss  credits;  (e)  Balance 
sheet  assets;  (/)  Balance  sheet  liabilities.  The  working  sheet 
takes  all  of  these  columns  and  adds  two  more  for  the  purpose 
of  taking  care  of  such  adjustments  as  are  needed  in  connection 
with  making  the  final  entries  involved  in  drawing  off  a  revenue 
statement  and  balance  sheet.  The  form  below  will  show  the 
headings  for  the  working  sheet. 

2.  Entries  on  the  Working  Sheet.  —  The  new  accounts  in- 
volved in  taking  off  the  working  sheet  are  entered  ordinarily 
directly  under  those  which  would  be  used  in  making  the  trial 
balance.  Instead  of  entering  these  items  in  the  trial  balance 
columns,  however,  the  new  account  entries  are  placed  in  the 
adjustment  column.  The  letter  placed  to  the  left  of  each 
entry  refers  to  the  list  of  items  involved  in  the  adjustments. 
These  items  appear  below.  After  the  adjustment  items  are 
properly  entered  and  carried  over  into  the  profit  and  loss  column 
or  the  balance  sheet  column,  as  may  be  required,  it  is  then 
possible  to  calculate  the  net  profits  which  are  entered  in  the  left 
column  of  the  profit  and  loss  column.  With  this  new  net  profit 
the  capital  account  or  total  net  profit  accumulated  may  be 
changed  to  correspond  with  the  final  total.  The  two  columns 
of  the  balance  sheet  should  then  balance  if  the  work  has  been 
correct. 

475 


476  ACCOUNTING  PRINCIPLES 

3.  The  Working  Sheet  and  the  Statement  —  The  working 
sheet  is  not  the  final  form  in  which  the  statements  are  commonly 
left.  It  is  only  preliminarj'  and  is  merely  an  aid  to  the  ac- 
countant in  bringing  the  data  together.  WTien  the  profit  and 
loss  items  and  the  balance  sheet  items  have  been  thus  assembled 
it  is  a  simple  matter  to  draw  off  the  revenue  statement  and 
balance  sheet  in  the  form  most  suitable  for  comprehension  by 
the  ordinary'  manager  or  stockholder  who  may  not  be  ac- 
quainted with  accounting  terminology. 

4.  Adjusting  Entries.  —  The  adjusting  entries  used  in  the 
working  sheet  are  as  follows: 

a.  Merchandise  inventory  end  of  the  period,  $10,200.00. 

b.  Accrued  taxes.  $150.00. 

c.  Reserv'e  for  bad  debts,  $180.00. 

d.  Reserve  for  depreciation  on  furniture  and  fixtures,  $100.00 

e.  Interest  accrued  on  notes  receivable,  $50.00. 
/.   Selling  ^laries  accrued,  $200.00. 

g.  Administrative  salari^  accrued,  $250.00. 


«f 


THE  WORKING  SHEET 


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INDEX 


Accounts: 
Accrued  expense,  137 
Accrued  income,  135 
Asset  account,  debits  and  credits,  26 
Balances  as  affected  by  transactions, 

34;  35 

Capital,  33 

Cash,  25 

Closing  of,  46 

Creditor  accounts,  26,  27 

Customer  accounts,  22 

Liability  accounts,  debit  and  credit  of, 
28 

Merchandise,  29,  31 

Period  covered  by,  21 

Personal,  34 

Profit  and  Loss  32 

Relation  to  statement   21 

Return  purchases  and  allowances.  74 

Return  sales  aad  allowances,  75 

Revenue  accounts,  29 

Trading,  74 
Account  sales,  250  252 
Admission  of  partners,  295,  297 
Appropriated  surplus,  385 
Assets,  I 

order  of  in  the  balance  sheet,  7 

classes  of,  7,  162 


B 


Balance  sheet: 

Comparative,  167 

Corporation.  5 

Form  of,  169,  172..  175,  176 

Individual  business,  5 

Methods  of  internal  analysis,  182 

Partnership,  5 

Relation  to  estimates,  168 

Showing  groups  of  items,  9 

Use  of  ratios  for  interpreting,  183,  184, 
i8s 

Uses  of,  162 
Bill  book,  214 
Bonds: 

Bond  discount,  365 

Bond  investment  account,  368 

Bond  premium,  367 . 

Bond  register,  406 


Bond  subscriptions,  364 

Treasury  bonds,  390 
Book  value  of  shares,  376 
Budgetary  accounts,  444 
Budget  and  cash  estimate,  173 
Budgets  and  statements,  156 


Capital  account,  33 

Capital  accounts  of  partners,  134 

Cash  journal,  72,  192 

Cash  requirements  of  a  business,  173,  174 

Checking  the  ledger,  45 

Classification    of    accounts    in    revenue 

statement,  146 
Classification  of  incomes  in  revenue  state- 
ment, 150 
Closing  accounts,  95 
Closing  accounts   through   ihe   journal, 

46,  47 
Columnar  cash  journal,  192 
Columnar  journals,  188 
Columnar  purchase  journal,  192 
Columnar  sales  journal,  193 
Commercial  papers: 

Acceptance,  62 

Design  of,  56 

Draft,  three-party,  62 

Promissory  note,  59 

Purchase  invoice,  57,  58 
Consignee  records,  245,  246,  248 
Consignments,  245 
Consignor  records.  249   262 
Consolidation  of  two  or  more  individual 

businesses  in  a  partnership,  133 
Controlling  accounts,  187.  196 
Corporate  organization,  328-338 

Bonds,  331 

Charter  and  by-laws,  333 

Common  stock,  330 

Corporate  organization  and  account- 
ing, 335 

Dividends,  334 

Liabilities  of  stockholders,  329 

Minute  book,  334 

Preferred  stock,  330 

Shares  without  par  value,  328 
Corporation,  2 
Corporation  accounting,  336 

Bond  register,  406 


479 


48o 


ACCOUNTING   PRINCIPLES 


Corporation  accounting  —  continued 

Book  value  of  stock  376 

Corporate  balance  sheet,  336,  339 

Discount  on  stock,  381 

Entry  of   exchange  of    property  for 
stock,  349 

Forfeited  stock,  36c 

Instahnent  records,  348 

Issue  of  corporate  shares  and  journal 
entries  of,  342,  343 

Opening  the  corporation  books,  458 

Premium  on  stock.  38c 

Stock  certificate,  402 

Stock  dividends,  379 

Stock  ledger.  404,  405 

Stock  transfer  book,  405 

Subscnption  ledger,  401,  402 

Subscriptions  to  stock,  343,  399 

Transfer  of  business  to  corporation.  352 

Unissued  stock,  34s 
Corporation  bonds,  364-373 

Bond  discoimt,  365 

Bond  investment  account,  368 

Bond  premiums,  367 

Bond  subscriptions,  364 

Treasury  bonds,  370 
Correcting  estimated  costs,  424 
Cost  terms,  428 


D 


Deferred  expense,  138 

Deferred  income,  140 

Delivery  expense,  149 

Depreciation : 
Causes  of,  114 
Constant   percentage   of   diminishing 

value,  116 
Definition,  114 

Depreciation    and    extraordinary    re- 
pairs, 124 
Depreciation  and  replacements,  126 
Depreciation  reserve,  118 
Depreciation  and  scrap  value,  122 
Methods  of  charging,  116 
Relation  of  repairs  to,  118,  120 
Relation  to  price  reductions,  115 
Sinking-fund  method  of  depreciation, 

121 
Straight-line.  116 

Direct  labor,  410 

Direct  material,  411 

Discount,  64,  65 

Discount  in  columnar  journals,  190 

Discount  in  the  special  journals,  75 


Discount  on  stock,  381 

Distribution  of  partnership  profits,  305, 

307 
Divided  joiunal,  71 
Dividend  book,  409 
Dividends,  declaration  of,  377 
Donated  stock,  386 
Draft: 

Acceptance,  62 

Bill  of  exchange,  62 

Check,  64 

Sight  draft,  63 

Time  draft,  62,  63 


Enterprise,  2 

Enterpriser,  2 

Erasures,  97 

Estimating  costs,  412 

Estimated  cost  data  journalized,  422 

Exchange,  62 

Exchange  of  property  for  stock,  349 

Executive  use  of  cost  data,  442 

Expenses: 

Apportionment  of,  112 

Nature  of,  13,  112 
Elxtraordinaiy  repairs,  124 


F 


Factory  accounting,  410-432 

Correcting  estimated  costs,  424 

Cost  terms,  428 

Direct  labor,  410 

Direct  material,  411 

Estimated  cost  data  journalized,  422 

Estimating  costs,  412 

Goods  in  process,  415,  416,  417 

Indirect  expense,  411 

Manufacturing  account,  414 
Financial  statement: 

Form  of,  6 

Showing  account  groups,  10 
Fixed  costs,  147 
Forfeited  stock,  360 


General  journal,  73,  89,  83 
General  ledger,  73 
Goods  in  process,  416 
Goodwill  in  partnership,  295,  297 


INDEX 


481 


Incomes,  11 

Nature  of,  12 
Indirect  expense,  411 
Individual  business  unit,  i 
Instalment  records,  348 
Interest: 

Calculation  of,  66-68 

Entry  in  columnar  cash  journal,  197 
Inventories: 

Calculation  of,  153,  154 

Merchandise,  30,  31 

Shipment,  255 

Stock  ledger,  152,  153 

Supply,  113 
Invoic6s  used  as  journals,  75 


Journal,  44: 

Cash  journal,  72,  78,  192 
Divided  journal,  71 
General  journal,  80,  83 
Memoranda  in,  97 
Notes  payable  journal,  219,  220 
Notes  receivable  journal,  216 
Purchase  journal,  72,  79,  192 
Sales  journal,  73,  79,  193 
Use  of,  44 


Ledgers: 

General  ledger,  73 

Kinds  of,  43 

Memoranda  in,  98 

Purchase  ledger,  195 

Sales  ledger,  196 

Stock  ledger,  404,  405 

Subscription  ledger,  401,  402 
Liabilities: 

Classes  of,  7,  8,  9,  163 

Definition  and  nature,  3 

Order  of  in  the  balance  sheet,  7 

Relation  to  assets,  164 
Liquidating  dividends,  314 
Loans  from  partners,  315 

M 

Manufacturing  account,  414 
Manufacturing  budget,  443 
Manufacturing  profit  and  loss  statement, 
433-445 


Comparative,  441 
Form  of,  434 
Sections  of,  438 


N 


Net  profits: 

Definition,  15 
Notes  payable  controlling  account,  220 
Notes  payable  journal,  219,  220 
Notes  receivable  controlling  account,  220 
Notes  receivable  discounted,  61 
Notes  receivable  journal,  216 


O 


Opening  account&thfough  journal,  48 
Opening  corporation  books,  458 
Opening  the  voucher  register,  462 


Partnership,  2,  294 
Partnership  accounting: 

Admission  of  partners,  295,  297 

Articles  of  partnership,  294 

Books  of  the  partnership,  294 

Distribution    of    partnership    profits, 
305,  307 

Goodwill  in  partnership,  295,  297 

Liquidating  dividends,  314 

Loans  from  partners,  315 

Overdrafts  of  capital,  323 

Priority  of  partnership  claims,  305,  306 

Reducing  capitals  to  profit  and  loss 
sharing  ratio,  322 

Retiring  partner's  interest,  301  ^ 
Petty  cash  book,  106,  108 
Petty  cash,  impressed  system  of,  106 
Petty  cash  journal,  107,  109 
Posting,  45 

Premium  on  stock,  384 
Profits  from  operation,  14 
Promissory  note,  59 
Proprietorship,  3,  4 
Purchase  journal,  72.  192 
Purchase  ledger,  195 


R 


Reserve  for  bad  debts,  143 
Reserve  for  sinking  fund,  393 
Retiring  partner's  interest,  301 
Return  purchases  and  allowances,  74 
Return  sales  and  allowances,  75 


482 


ACCOUNTING  PRINCIPLES 


Re\'enue  statement: 
Coastruction  from  list  <A  items,  15 
Fonn  of,  16 
Gross  proSts,  14 
Income  balances,  14 
Profits  from  operations,  14 
Relation  of  budgets  to,  156 
Uses  <rf,  17 


Sales  journal,  73,  193 

Sales  ledger,  196 

Selling  expenses,  149 

Shipment  inventor>'.  255 

Shipment  journal,  376 

Shipment  profit  and  loss,  254 

Standard  costs,  439 

Stock  certificates,  402 

Stodk  dividends,  379 

Stock  ledger,  153,  404.  405 

Stock  transfer  hook,  403 

Straight -line  depreciation,  116 

Subscription  ledger,  401 

Subscription  rights,  value  of,  380 

Subscriptions  to  stock,  343,  399 

Siqiply  inventories,  113 

Surplu<i  3S4 
Appropriated,  385 
Available,  384.  391,  392 


Donated  stock,  386 
Sinking  fund  reserve,  393 
Surplus  reser\es,  396 


Trading  account,  74,  239 

Transferring  of  assets  and  Uabilities  to  a 

new  concern,  130-133 
Transfo'  of  business  to  a  oorporatioo,  352 
Treasury  bonds,  370 
Trial  balance,  36 


Unissued  stock,  345 


V 


Valley  Furniture  Store: 
April  transactions,  463-470 
Februar>'  transactions,  227-236 
January  transactions,  99-105 
Ledger  accounts  for  April,  460 
Ledger  accounts  for  February,  222 
Ledger  accounts  of.  93-95 
March  transactions.  285-295 

Valuation  reser>'e5,  396 

Voucher  check  449  454 

Voucher  record.  447-457 

Voucher  register  and  purchase  ledger,  456 

Vouchers,  447.  452,  453 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 

Los  Angeles 
This  book  is  DUE  on  the  last  date  stamped  below. 


JAN     8  1962 
jyi_28J965. 


JUL  2  7  1976    . 

AUG   3 -a  Ob 


REMOVED  FROM  SN/ G  SHEl/ 


Form  L9-32m-8,'58(5876s4)444 


UCLA-GSM  Library 

HF5635B413a 


L  005  003  502  1 


'SOUTHERN   BRANrw^^^^^^^^^^^^ 

/ERSITY  OF  I  

LIBR^        """a 6'0T259  721    7 

LOS  ANGELE  " 


J 


